Management Accounting
Fundamentals
Module 8
Flexible budgets and
decentralization
Lectures and handouts by:
Shirley Mauger, HB Comm, CGA
Module 8 - Table of Contents
Content
Part
1
2
N/A
3
4
5
6
7
8
9
8.1
8.2
8.3
8.4
8.5
Flexible budgets
Variable overhead variances
Overhead rates and standard costing
Fixed overhead budget and volume variances
Computer illustration 8-1: Fixed costs in a flexible
budget
8.6 Full income statement variance analysis
8.7 Decentralization in organizations
8.8 Segment reporting
8.9 Revenue variance and marketing expense analysis
8.10 Rate of return and residual income
Review question: Variance analysis, working backwards
from data
Review question: Segmented statements
Review question: Segmented statements, ROI and residual
income
Review question: Multiple choice
MA1 – MODULE 8
Part 1
Flexible budgets
Variable overhead
variances
Topics 8.1-8.2
3
2
Part 1 – Flexible budgets (Topic 8.1)
Prepare a flexible budget, and explain the advantages of the
flexible budget approach over the static budget approach. (Level 1)
Static budget
• Designed for only one level of activity
• If activity is lower than budget, variable cost variances
will usually be favorable
• When analyzing variances, volume and spending
variances are combined so cannot be controlled.
• Does not indicate whether output was produced
efficiently
4
Part 1 – Flexible budgets (Topic 8.1)
Prepare a flexible budget, and explain the advantages of the
flexible budget approach over the static budget approach. (Level 1)
Flexible budget
• Designed to cover a range of activity
• Can be used to develop budgeted costs at
any point within the relevant range
• Usually compares actual and budgeted
results at the same level of activity
• Identifies the ability to control costs, and
efficiency.
5
Part 1 – Flexible budgets (Topic 8.1)
Parker Co. manufactures and sells desks.
Budgeted variable costs per desk are:
Direct materials cost
Direct manufacturing labour
Variable overhead
Total variable costs/unit
$ 130
52
48
$ 230
•Budgeted selling price is $300 per desk
•Fixed overhead costs are expected to be $52,500
•The static budget for the year 2008 is based on selling
1,500 desks
What is the static-budget operating income?
Stop the audio, turn to page 1 of handout 1.
(ma1_mod8_handout1.pdf)
6
Part 1 – Flexible budgets (Topic 8.1)
Parker Co.
Unit costs
Static
Budget
$ 300
$ 450,000
230
(345,000)
52,500
(52,500)
Activity level
Sales:
Variable
costs
Fixed
overhead
1,500
Income from
operations
$ 52,500
1. What is the static-budget operating income?
7
Part 1 – Flexible budgets (Topic 8.1)
Parker Co.
Actual
Activity level
Static
Budget
1,300
1,500
Sales: $300 $410,000
$450,000
Variable
costs $230
(330,000)
(345,000)
(61,500)
(52,500)
$ 18,500
$52,500
Fixed
overhead
Income from
operations
Actual costs incurred….
8
Part 1 – Flexible budgets (Topic 8.1)
Parker Co.
Actual
Activity level
Variance
Static
Budget
1,300
200
1,500
Sales: $300 $410,000
$40,000U
$450,000
(330,000)
15,000F
(345,000)
(61,500)
9,000U
(52,500)
$ 18,500
$ 34,000U
$52,500
Variable
costs $230
Fixed
overhead
Income from
operations
Budget variances….
9
Part 1 – Flexible budgets (Topic 8.1)
Parker Co.
Actual
Activity level
Is this really Static
favorable? Budget
Variance
1,300
200
1,500
Sales: $300 $410,000
$40,000U
$450,000
(330,000)
15,000F
(345,000)
(61,500)
9,000U
(52,500)
$ 18,500
$ 34,000U
$52,500
Variable
costs $230
Fixed
overhead
Income from
operations
Budget variances….
10
Part 1 – Flexible budgets (Topic 8.1)
Parker Co.
Activity level
Actual
Flexible
Budget
1,300
1,300
Static
Budget
1,500
Sales: $300 $410,000
$450,000
Variable
costs $230
(330,000)
(345,000)
(61,500)
(52,500)
$ 18,500
$52,500
Fixed
overhead
Income from
operations
2. Prepare a flexible budget at the actual
level of operations.
11
Part 1 – Flexible budgets (Topic 8.1)
$300 per unit
x 1,300 Actual
units
Activity level
Parker Co.
Flexible
Budget
Static
Budget
1,300
1,300
1,500
Sales: $300 $410,000
$390,000
$450,000
Variable
costs $230
Fixed
overhead
Income from
operations
(330,000)
(345,000)
(61,500)
(52,500)
$ 18,500
$52,500
2. Prepare a flexible budget at the actual
level of operations.
12
Part 1 – Flexible budgets (Topic 8.1)
$230 per unit
x 1,300 Actual
units
Activity level
Parker Co.
Flexible
Budget
Static
Budget
1,300
1,300
1,500
Sales: $300 $410,000
$390,000
$450,000
Variable
costs $230
(299,000)
(345,000)
Fixed
overhead
Income from
operations
(330,000)
(61,500)
(52,500)
$ 18,500
$52,500
2. Prepare a flexible budget at the actual
level of operations.
13
Part 1 – Flexible budgets (Topic 8.1)
Fixed costs
remain the
Actual
same
Activity level
Parker Co.
Flexible
Budget
Static
Budget
1,300
1,300
1,500
Sales: $300 $410,000
$390,000
$450,000
Variable
costs $230
(330,000)
(299,000)
(345,000)
(61,500)
(52,500)
(52,500)
Fixed
overhead
Income from
operations
$ 18,500 $20,000 U $ 38,500
$14,000 U
$52,500
2. Prepare a flexible budget at the actual
level of operations.
14
Part 1 – Flexible budgets (Topic 8.1)
Parker Co.
Flexible
Budget
Sales
volume
variance
0
1,300
200U
Sales: $300 $410,000 $20,000 F
$390,000
$450,000
31,000 U (299,000)
(345,000)
Activity level
Variable
costs $230
Fixed
overhead
Income from
operations
Actual
Flexible
budget
variance
1,300
(330,000)
(61,500)
9,000 U
Static
Budget
1,500
(52,500)
0
(52,500)
$ 18,500 $20,000 U $ 38,500
$14,000 U
$52,500
The flexible budget variance is also called
budget variance.
15
Part 1 – Flexible budgets (Topic 8.1)
Parker Co.
Activity level
Actual
Flexible
budget
variance
1,300
0
Sales: $300 $410,000 $20,000 F
Variable
costs $230
Fixed
overhead
Income from
operations
(330,000)
(61,500)
Flexible
Budget
Sales
volume
variance
Static
Budget
1,300
200U
1,500
$390,000 $ 60,000 U $450,000
31,000 U (299,000)
9,000 U
46,000 F (345,000)
(52,500)
0
(52,500)
$ 18,500 $20,000 U $ 38,500
$14,000 U
$52,500
A sales volume variance identifies the variances
resulting from changes in activity levels.
16
Part 1 – Flexible budgets (Topic 8.1)
Parker Co.
Actual
Activity level
Flexible
budget
variance
Flexible
Budget
1,300
0
1,300
Fixed
OH never
shows a sales$390,000
volume 31,000
variance
(330,000)
U (299,000)
Sales: $300 $410,000 $20,000 F
Variable
costs $230
Fixed
overhead
Income from
operations
(61,500)
9,000 U
Sales
volume
variance
Static
Budget
200U
1,500
$ 60,000 U $450,000
46,000 F (345,000)
(52,500)
0
(52,500)
$ 18,500 $20,000 U $ 38,500
$14,000 U
$52,500
A sales volume variance identifies the variances
resulting from changes in activity levels.
17
Part 1 – Flexible budgets (Topic 8.1)
Parker Co.
Activity level
Actual
Flexible
budget
variance
1,300
0
Sales: $300 $410,000 $20,000 F
Variable
costs $230
Fixed
overhead
Income from
operations
(330,000)
(61,500)
Flexible
Budget
Sales
volume
variance
Static
Budget
1,300
200U
1,500
$390,000 $ 60,000 U $450,000
31,000 U (299,000)
9,000 U
46,000 F (345,000)
(52,500)
0
(52,500)
$ 18,500 $20,000 U $ 38,500
$14,000 U
$52,500
A closer look at overhead…
18
Part 1 – Flexible budgets (Topic 8.1)
STANDARD COST CARD – 1 DESK
Direct materials:
Direct labour (5 hours at $12/hour
Variable overhead (5 DLH at $8.80/hour)
*Fixed overhead (5 DLH at $7.00/hour)
Total standard costs per desk:
$126
60
44
35
$265
(*Based on a denominator level of activity of 1,500 desks)
19
Part 1 – Flexible budgets (Topic 8.1)
Parker Co.
Actual
Activity level
1,300
Flexible
budget
variance
0
DM:
Flexible
Budget
Sales
volume
variance
Static
Budget
1,300
200U
1,500
1,500 x $126
Sales: $300 $410,000 $20,000
$390,000
DL:F 1,500
x $ $6060,000 U $450,000
VOH: 1,500 x $ 44
Direct mat. (180,000)
(189,000)
Direct labour
(87,800)
Variable OH
(62,200)
Fixed OH
Income from
operations
(61,500)
(90,000)
(66,000)
9,000 U
(52,500)
0
(52,500)
$ 18,500 $20,000 U $ 38,500
$14,000 U
$52,500
20
Part 1 – Flexible budgets (Topic 8.1)
Parker Co.
Actualx $126
Flexible
DM: 1,300
DL: 1,300 x $ budget
60
VOH: 1,300 x $variance
44
Activity level
1,300
0
Flexible
Budget
Sales
volume
variance
Static
Budget
1,300
200U
1,500
Sales: $300 $410,000 $20,000 F
$390,000 $ 60,000 U $450,000
Direct mat.
(180,000)
(163,800)
(189,000)
Direct labour
(87,800)
(78,000)
(90,000)
Variable OH
(62,200)
(57,200)
Fixed OH
Income from
operations
(61,500)
9,000 U
(66,000)
(52,500)
0
(52,500)
$ 18,500 $20,000 U $ 38,500
$14,000 U
$52,500
21
Part 1 – Flexible budgets (Topic 8.1)
Parker Co.
Activity level
Actual
Flexible
budget
variance
1,300
0
Sales: $300 $410,000 $20,000 F
Direct mat.
(180,000)
Flexible
Budget
Sales
volume
variance
Static
Budget
1,300
200U
1,500
$390,000 $ 60,000 U $450,000
16,200 U (163,800)
25,200 F (189,000)
Direct labour
(87,800)
9,800 U
(78,000)
12,000F
(90,000)
Variable OH
(62,200)
5,000 U
(57,200)
8,800F
(66,000)
Fixed OH
Income from
operations
(61,500)
9,000 U
(52,500)
0
(52,500)
$ 18,500 $20,000 U $ 38,500
$14,000 U
$52,500
What drives variable overhead costs?
22
Part 1 – Flexible budgets (Topic 8.1)
An activity base for variable overhead:
• Should be a causal relationship
• Should not be expressed in a currency
• Should be simple and easy to understand
23
Part 1 – Flexible budgets (Topic 8.1)
Parker Co.
Actual
Explain
Activity
levelthe $5,000
1,300
variance
Flexible
budget
variance
0
Sales: $300 $410,000 $20,000 F
Direct mat.
(180,000)
Flexible
Budget
Sales
volume
variance
Static
Budget
1,300
200U
1,500
$390,000 $ 60,000 U $450,000
16,200 U (163,800)
25,200 F (189,000)
Direct labour
(87,800)
9,800 U
(78,000)
12,000F
(90,000)
Variable OH
(62,200)
5,000 U
(57,200)
8,800F
(66,000)
Fixed OH
Income from
operations
(61,500)
9,000 U
(52,500)
0
(52,500)
$ 18,500 $20,000 U $ 38,500
$14,000 U
$52,500
3. Calculate the variable overhead spending and
efficiency variances.
24
Part 1 – Variable overhead variances (Topic 8.2)
Prepare a variable overhead performance report using the
flexible budget to show only a spending variance and to show
both spending and efficiency variances. (Level 1)
Variable overhead variances
(1)
AQ x AR
$62,200
(given)
(2)
AQ x SR
Spending variance:
(1) – (2)
(3)
SQ x SR
Efficiency variance:
(2) – (3)
Total variance (1)-(3)
25
Part 1 – Variable overhead variances (Topic 8.2)
Variable overhead variances
(1)
AQ x AR
$62,200
(given)
(2)
AQ x SR
Spending variance:
(1) – (2)
(3)
SQ x SR
5 hours x 1,500
desks x $8.80 =
$57,200
Efficiency variance:
(2) – (3)
Total variance $62,200 - $57,200=$5,000 U
26
Part 1 – Variable overhead variances (Topic 8.2)
Variable overhead variances
(1)
AQ x AR
$62,200
(given)
(2)
AQ x SR
6 hours x 1,300
desks x $8.80 =
$68,640
Spending variance:
$62,200-68,640 =
$6,440 F
(3)
SQ x SR
5 hours x 1,500
desks x $8.80 =
$57,200
Efficiency variance:
(2) – (3)
Total variance $62,200 - $57,200=$5,000 U
27
Part 1 – Variable overhead variances (Topic 8.2)
Variable overhead variances
(1)
AQ x AR
$62,200
(given)
(2)
AQ x SR
6 hours x 1,300
desks x $8.80 =
$68,640
Spending variance:
$62,200-68,640 =
$6,440 F
(3)
SQ x SR
5 hours x 1,500
desks x $8.80 =
$57,200
Efficiency variance:
$68,640-57,200 =
$11,440 U
Total variance $62,200 - $57,200=$5,000 U
28
Part 1 – Variable overhead variances (Topic 8.2)
What is the significance of the:
Spending variance?
•If based on actual hours worked it indicates how much
should have been spent on variable overhead.
(AQxAR)-(AQ-SR)
$62,200 – (6500 hours x $8.80)
$62,200-68,640 = $6,440 F
Efficiency variance?
•If based on actual hours worked it indicates how many
more resources were used as a result of inefficient use of
the activity base. (DLH in this case)
(AQxSR)-(SQ-SR)
(6500 hours x $8.80)-(7,500 hours x $8.80)
$68,640-57,200 = 11,440 U
29
MA1 – MODULE 8
Part 2
Overhead rates and standard
costing
Fixed overhead budget and
volume variances
Full income statement variance
analysis
Topics 8.3-8.6
30
Part 2 – Overhead rates and standard costing (Topic 8.3)
Fixed cost:
•Total cost remains constant
regardless of changes in activity
•Unit cost becomes smaller as
the activity increases.
e.g. The rental cost for the
sports retailer’s shop is fixed
Number
of skateboards
sold
Cost of
rent per
skateboard
Total
cost of
rent
1
$2,000
$2,000
2
$1,000
$2,000
100
$20
$2,000
Cost of store rent
Explain the significance of the denominator activity figure in
determining the standard cost of a unit of product. (Level 1)
Skateboards sold
31
Part 2 – Overhead rates and standard costing (Topic 8.3)
STANDARD COST CARD – 1 DESK
Direct materials:
Direct labour (5 hours at $12/hour
Variable overhead (5 DLH at $8.80/hour)
*Fixed overhead (5 DLH at $7.00/hour)
Total standard costs per desk:
$126
60
44
35
$265
(*Based on a denominator level of activity of 1,500 desks)
Stop the audio, turn to page 1 of handout 1.
(ma1_mod8_handout1.pdf)
32
Part 2 – Overhead rates and standard costing (Topic 8.3)
Applying overhead costs
Variable overhead
Estimated total
manufacturing
overhead cost
At denominator
level of activity
$66,000
Estimated total
units in the
allocation base
Denominator
level of activity
1,500 desks x 5
hours per desk =
7,500 hours
Predetermined
= overhead rate
$8.80 per
direct labour
hour
33
Part 2 – Overhead rates and standard costing (Topic 8.3)
Applying overhead costs
Fixed overhead
Estimated total
manufacturing
overhead cost
At denominator
level of activity
$52,500
Estimated total
units in the
allocation base
Denominator
level of activity
1,500 desks x 5
hours per desk =
7,500 hours
Predetermined
= overhead rate
$7.00 per
direct labour
hour
34
Part 2 – Overhead rates and standard costing (Topic 8.3)
Applying overhead costs in
a standard costing system
Fixed overhead
Manufacturing overhead
Actual
costs
incurred
Overhead
applied
Manufacturing overhead
$61,500
1,300 desks at
$7 per DLH x 5
hours =
$45,500
$16,000
underapplied
35
Part 2 – Fixed overhead budget and volume variances
(Topic 8.4)
Compute and properly interpret the fixed overhead budget and
volume variances. (Level 1)
Fixed overhead variances
(1)
Actual cost
$61,500
(2)
BU x SQ x SR
Budgeted units
= Denominator
level of activity
Budget variance:
(1)-(2)
(3)
AU x SQ x SR
Volume variance:
(2)-(3)
Total variance (1)-(3)
36
Part 2 – Fixed overhead budget and volume variances
(Topic 8.4)
Fixed overhead variances
(1)
Actual cost
$61,500
(2)
BU x SQ x SR
Budgeted units
= Denominator
level of activity
Budget variance:
(1)-(2)
(3)
AU x SQ x SR
1,300 desks x 5
hours x $7=
$45,500
Volume variance:
(2)-(3)
Total variance $61,500 - $45,500 = $16,000 U
37
Part 2 – Fixed overhead budget and volume variances
(Topic 8.4)
Fixed overhead variances
(1)
Actual cost
$61,500
(2)
BU x SQ x SR
1,500 desks x 5
hours x $7=
$52,500
Budget variance:
(1)-(2)
(3)
AU x SQ x SR
1,300 desks x 5
hours x $7=
$45,500
Volume variance:
(2)-(3)
Total variance $61,500 - $45,500 = $16,000 U
38
Part 2 – Fixed overhead budget and volume variances
(Topic 8.4)
More was spent
than planned
Fixed overhead variances
(1)
Actual cost
$61,500
(2)
BU x SQ x SR
1,500 desks x 5
hours x $7=
$52,500
Budget variance:
$61,500 - $52,500 =
$9,000 U
(3)
AU x SQ x SR
1,300 desks x 5
hours x $7=
$45,500
Volume variance:
(2)-(3)
Total variance $61,500 - $45,500 = $16,000 U
39
Part 2 – Fixed overhead budget and volume variances
(Topic 8.4)
200 less units were
produced and sold
Fixed overhead variances
(1)
Actual cost
$61,500
(2)
BU x SQ x SR
1,500 desks x 5
hours x $7=
$52,500
Budget variance:
$61,500 - $52,500 =
$9,000 U
(3)
AU x SQ x SR
1,300 desks x 5
hours x $7=
$45,500
Volume variance:
$52,500 - $45,500 =
$7,000 U
Total variance $61,500 - $45,500 = $16,000 U
40
Part 2 – Full income statement variance analysis (Topic 8.6)
Prepare an income statement incorporating variance analysis.
(Level 2)
Product and period costs
Absorption
Costing
Variable
Costing
Direct Materials
Product
Costs
Product
Costs
Direct Labour
Variable Manufacturing OH
Fixed Manufacturing OH
Period
Costs
Variable Selling and Admin Exp.
Period
Costs
Fixed Selling and Admin Exp.
© M cGraw-Hill Ryerson Limited., 2004
41
Part 2 – Full income statement variance analysis (Topic 8.6)
Product and period costs
Absorption
Costing
Direct Mat.
Product
Costs
Write off all
variances to cost
of goods sold
Direct Labour
VMOH
FMOH
Period
Costs
Variable S&A
Fixed S&A
No variances.
Report as period
costs
© M cGraw-Hill Ryerson Limited., 2004
42
Part 2 – Full income statement variance analysis (Topic 8.6)
Income statement format – Absorption costing
Sales
$xxx
Cost of goods sold (standard costs)
$xxx
Writeoff variances
Direct materials price and quantity
xxx
Direct labour rate and efficiency
xxx
Variable overhead spending and efficiency xxx
Fixed overhead spending and volume
xxx
Adjusted cost of goods sold
xxx
Gross profit
xxx
Variable selling and administration
xxx
Fixed selling and administration
xxx
Net income
$xxx
43
Part 2 – Full income statement variance analysis (Topic 8.6)
Product and period costs
Write off all
variances to cost
of goods sold
Variable
Costing
Direct Mat.
Direct Labour
Product
Costs
VMOH
FMOH
No variances.
Report as period
costs
Variable S&A
Period
Costs
Fixed S&A
© M cGraw-Hill Ryerson Limited., 2004
44
Part 2 – Full income statement variance analysis (Topic 8.6)
Income statement format – Variable costing
Sales
$xxx
Cost of goods sold (standard costs)
$xxx
Writeoff variances
Direct materials price and quantity
xxx
Direct labour rate and efficiency
xxx
Variable overhead spending and efficiency xxx
Adjusted cost of goods sold
xxx
Variable selling and administration
xxx xxx
Contribution margin
xxx
Fixed manufacturing overhead
xxx
Fixed selling and administration
xxx
Net income
$xxx
45
MA1 – MODULE 8
Part 3
Decentralization in
organizations
Segment reporting
Topics 8.7-8.8
46
Part 3 – Decentralization in organizations (Topic 8.7)
Differentiate between cost centres, profit centres, and
investment centres, and explain how performance is measured
in each. (Level 2)
Decentralization
Decision making is
spread throughout
the organization
Board of directors
CEO
Western
division
Consumer
products
Industrial
products
Eastern
division
Consumer
products
Director of
human
resources
Industrial
products
47
Part 3 – Decentralization in organizations (Topic 8.7)
Segment
‘Any part or activity of an organization
about which the manager seeks cost,
revenue or profit data.’
Chapter 12, p.547
48
Part 3 – Decentralization in organizations (Topic 8.7)
Responsibility
accounting
• Gives managers greater control over their
segments
• Keeps decisions in the hands of people who
see and understand the problems
• Serves as a motivating tool
• Enhances employee development
• Promotes job satisfaction
• Provides a basis for evaluation
49
Part 3 – Decentralization in organizations (Topic 8.7)
Performance is measured
based on control over:
Costs
Revenues
Investments
Cost
centre
Profit
centre
Investment
centre
50
Part 3 – Decentralization in organizations (Topic 8.7)
Responsibility centres
Investment
centre
Cost
centre
Board of directors
CEO
Eastern
division
Western
division
Consumer
products
Industrial
products
Consumer
products
Profit centres
Director of
human
resources
Industrial
products
51
Part 3 – Segment reporting (Topic 8.8)
Prepare a segmented income statement using the contribution
format, and explain the difference between traceable fixed costs
and common fixed costs. (Level 1)
Segment reporting
• Provides more information on profitability than
company wide reports
• Can highlight problems and opportunities within
an organization
• Reduces the effects of cross subsidization
• Costs not traced directly to the segment
• Costs allocated using an inappropriate base
52
Part 3 – Segment reporting (Topic 8.8)
Classifying costs for segment reporting
Variable
Fixed
Traced
directly to
the segment
Variable cost
of goods sold
Stop the audio, turn to page 4 of handout 1.
(ma1_mod8_handout1.pdf)
53
Part 3 – Segment reporting (Topic 8.8)
Classifying costs for segment reporting
Variable
Fixed
Traced
directly to
the segment
Traceable
Directly supports
the segment. Can
become common
as segments are
further divided.
• Salary of the
segment manager.
Common
Supports more
than one segment
and not traceable
to any segment
• Salary of the CEO
• Shared
equipment costs
54
Part 3 – Segment reporting (Topic 8.8)
Classifying costs for segment reporting
Variable
Fixed
Traced
directly to
the segment
Traceable
Discretionary
Can be controlled
by the segment
manager
• Advertising for
that segment
Common
Supports more
than one segment
and not traceable
to any segment
Committed
CanNOT be
controlled by the
segment manager
• Depreciation of
plant facilities
55
Part 3 – Segment reporting (Topic 8.8)
Segment reporting format
Sales
(Variable costs)
= Contribution margin
• Identifies what happens to profits as volume
changes
• Useful for short run decisions such as temporary
uses of capacity (chapter 13)
56
Part 3 – Segment reporting (Topic 8.8)
Segment reporting format
Sales
(Variable costs)
= Contribution margin
(Traceable fixed costs)
= Segment margin
• Useful for long run decisions
• Identifies margin available after a segment
covers its own costs
• A segment that cannot cover its own costs
should be discontinued
57
Part 3 – Segment reporting (Topic 8.8)
Segment reporting format
Sales
(Variable costs)
= Contribution margin
(Traceable fixed costs)
= Segment margin
(Common costs)
= Net income
• Corporate wide income
58
Part 3 – Segment reporting (Topic 8.8)
Restructuring a segmented income statement
Stop the audio, and turn to problem
12-16, page 592-593 and page 5 of
handout 1.
59
Part 3 – Segment reporting (Topic 8.8)
Restructuring a segmented income statement
Variable
S. Europe Mid.Europe N.Europe
Costs
Sales
€ 300,000
€800,000 €700,000
Territorial expenses
Cost of goods sold
Salaries
Insurance
Advertising
Depreciation
Shipping
Total territorial expenses
Income/loss before corp.exp.
Corporate expenses
Advertising (general)
General administrative
Total corporate expenses
Net operating income(loss)
93,000
54,000
9,000
105,000
21,000
15,000
297,000
3,000
15,000
20,000
35,000
€(32,000)
240,000
56,000
16,000
240,000
32,000
32,000
616,000
184,000
315,000
112,000
14,000
245,000
28,000
42,000
756,000
(56,000)
40,000
35,000
20,000
20,000
60,000
55,000
€124,000 €(111,000)
problem 12-16, page 592-593
60
Part 3 – Segment reporting (Topic 8.8)
Restructuring a segmented income statement
Traceable
S. Europe Mid.Europe N.Europe
Sales fixed costs
€ 300,000
€800,000 €700,000
Territorial expenses
Cost of goods sold
Salaries
Insurance
Advertising
Depreciation
Shipping
Total territorial expenses
Income/loss before corp.exp.
Corporate expenses
Advertising (general)
General administrative
Total corporate expenses
Net operating income(loss)
93,000
54,000
9,000
105,000
21,000
15,000
297,000
3,000
15,000
20,000
35,000
€(32,000)
240,000
56,000
16,000
240,000
32,000
32,000
616,000
184,000
315,000
112,000
14,000
245,000
28,000
42,000
756,000
(56,000)
40,000
35,000
20,000
20,000
60,000
55,000
€124,000 €(111,000)
problem 12-16, page 592-593
61
Part 3 – Segment reporting (Topic 8.8)
Restructuring a segmented income statement
Sales
Territorial expenses
Cost of goods sold
Salaries
Insurance
Advertising
Depreciation
Shipping Common
Total territorial fixed
expenses
costs
Income/loss before corp.exp.
Corporate expenses
Advertising (general)
General administrative
Total corporate expenses
Net operating income(loss)
S. Europe Mid.Europe N.Europe
€ 300,000
€800,000 €700,000
93,000
54,000
9,000
105,000
21,000
15,000
297,000
3,000
15,000
20,000
35,000
€(32,000)
240,000
56,000
16,000
240,000
32,000
32,000
616,000
184,000
315,000
112,000
14,000
245,000
28,000
42,000
756,000
(56,000)
40,000
35,000
20,000
20,000
60,000
55,000
€124,000 €(111,000)
problem 12-16, page 592-593
62
Part 3 – Segment reporting (Topic 8.8)
SOLUTION - In €s
Sales
Less variable expenses:
Cost of goods sold
Shipping expense
Total variable expenses
Contribution margin
Total S. Eur. Mid.Eur
N.Eur.
1,800,000 300,000 800,000. 700,000
648,000 93,000
89,000 15,000
737,000 108,000
1,063,000 192,000
240,000
32,000
272,000
528,000
315,000
42,000
357,000
343,000
Variable
Costs
problem 12-16, handout 1 page 5
63
Part 3 – Segment reporting (Topic 8.8)
SOLUTION - In €s
Sales
Less variable expenses:
Cost of goods sold
Shipping expense
Total variable expenses
Contribution margin
Less traceable fixed exp.
Salaries
Insurance
Advertising
Depreciation
Total traceable fixed exp.
Territorial seg. margin
Total S. Eur. Mid.Eur
N.Eur.
1,800,000 300,000 800,000. 700,000
648,000 93,000
89,000 15,000
737,000 108,000
1,063,000 192,000
222,000 54,000
39,000
9,000
590,000 105,000
81,000 21,000
932,000 189,000
131,000
3,000
240,000
32,000
272,000
528,000
315,000
42,000
357,000
343,000
56,000 112,000
16,000
14,000
240,000 245,000
32,000
28,000
344,000 399,000
184,000 (56,000)
Traceable
fixed costs
problem 12-16, handout 1 page 5
64
Part 3 – Segment reporting (Topic 8.8)
SOLUTION - In €s
Sales
Less variable expenses:
Cost of goods sold
Shipping expense
Total variable expenses
Contribution margin
Less traceable fixed exp.
Salaries
Insurance
Advertising
Depreciation
Total traceable fixed exp.
Territorial seg. margin
Less common fixed exp.
Advertising (gen.)
General admin.
Total common fixed exp.
Net operating loss
Total S. Eur. Mid.Eur
N.Eur.
1,800,000 300,000 800,000. 700,000
648,000 93,000
89,000 15,000
737,000 108,000
1,063,000 192,000
222,000 54,000
39,000
9,000
590,000 105,000
81,000 21,000
932,000 189,000
131,000
3,000
90,000
60,000
150,000
(19,000)
240,000
32,000
272,000
528,000
315,000
42,000
357,000
343,000
56,000 112,000
16,000
14,000
240,000 245,000
32,000
28,000
344,000 399,000
184,000 (56,000)
Common
fixed costs
problem 12-16
65
Part 3 – Segment reporting (Topic 8.8)
SOLUTION - In €s
Sales
Less variable expenses:
Cost of goods sold
Shipping expense
Total variable expenses
Contribution margin
Less traceable fixed exp.
Salaries
Insurance
Advertising
Depreciation
Total traceable fixed exp.
Territorial seg. margin
Less common fixed exp.
Advertising (gen.)
General admin.
Total common fixed exp.
Net operating loss
Total S. Eur. Mid.Eur
N.Eur.
1,800,000 300,000 800,000. 700,000
648,000 93,000
89,000 15,000
737,000 108,000
1,063,000 192,000
222,000 54,000
39,000
9,000
590,000 105,000
81,000 21,000
932,000 189,000
131,000
3,000
90,000
60,000
150,000
(19,000)
240,000
32,000
272,000
528,000
315,000
42,000
357,000
343,000
56,000 112,000
16,000
14,000
240,000 245,000
32,000
28,000
344,000 399,000
184,000 (56,000)
Which is covering its
traceable costs?
problem 12-16
66
Part 3 – Segment reporting (Topic 8.8)
SOLUTION - In €s
Sales
Less variable expenses:
Cost of goods sold
Shipping expense
Total variable expenses
Contribution margin
Less traceable fixed exp.
Salaries
Insurance
Advertising
Depreciation
Total traceable fixed exp.
Territorial seg. margin
Less common fixed exp.
Advertising (gen.)
General admin.
Total common fixed exp.
Net operating loss
Total S. Eur. Mid.Eur.
1,800,000 300,000 800,000
N.Eur.
700,000
648,000 93,000
89,000 15,000
737,000 108,000
1,063,000 192,000
315,000
42,000
357,000
343,000
240,000
32,000
272,000
528,000
222,000 54,000
56,000 112,000
39,000
9,000
16,000
14,000
590,000 105,000 240,000 245,000
81,000 21,000
32,000
28,000
932,000 189,000 344,000 399,000
131,000
S. Europe3,000
sales184,000
are lower
(56,000)
than mid. Europe, however,
90,000
salaries are comparable
60,000
150,000
(19,000)
problem 12-16
67
Part 3 – Segment reporting (Topic 8.8)
SOLUTION - In €s
Total S. Eur. Mid.Eur
N.Eur.
1,800,000 300,000 800,000. 700,000
Sales
Less variable expenses:
648,000 93,000 240,000 315,000
Cost of goods sold
89,000 15,000
32,000
42,000
Shipping expense
737,000 108,000 272,000 357,000
Total variable expenses
1,063,000 192,000 528,000 343,000
Contribution margin
Less traceable fixed exp.
222,000 54,000
56,000 112,000
Salaries
39,000
9,000
16,000
14,000
Insurance
590,000 105,000 240,000 245,000
Advertising
81,000 21,000
32,000
28,000
Depreciation
932,000 189,000 344,000 399,000
Total traceable fixed exp.
131,000
3,000 184,000 (56,000)
Territorial seg. margin
Less common fixed exp. S. Europe spends less on
90,000 than mid. Europe.
Advertising (gen.)
advertising
60,000
General admin.
Is this
a reason for low sales?
150,000
Total common fixed exp.
problem 12-16 68
(19,000)
Net operating loss
Part 3 – Segment reporting (Topic 8.8)
SOLUTION - In €s
Total S. Eur. Mid.Eur
N.Eur.
1,800,000 300,000 800,000. 700,000
Sales
Less variable expenses:
648,000 93,000 240,000 315,000
Cost of goods sold
89,000 15,000
32,000
42,000
Shipping expense
737,000 108,000 272,000 357,000
Total variable expenses
1,063,000 192,000 528,000 343,000
Contribution margin
Less traceable fixed exp.
222,000 54,000
56,000 112,000
Salaries
39,000
9,000
16,000
14,000
Insurance
590,000 105,000 240,000 245,000
Advertising
81,000 21,000
32,000
28,000
Depreciation
932,000 189,000 344,000 399,000
Total traceable fixed exp.
131,000
3,000 184,000 (56,000)
Territorial seg. margin
Less common fixed exp. N. Europe spends twice
90,000
Advertising (gen.)
as
much on sales
60,000
General admin.
salaries
as Mid. Europe
150,000
Total common fixed exp.
problem 12-16 69
(19,000)
Net operating loss
Part 3 – Segment reporting (Topic 8.8)
SOLUTION - In €s
Sales
Less variable expenses:
Cost of goods sold
Shipping expense
Total variable expenses
Contribution margin
Less traceable fixed exp.
Salaries
Insurance
Advertising
Depreciation
Total traceable fixed exp.
Territorial seg. margin
Less common fixed exp.
Advertising (gen.)
General admin.
Total common fixed exp.
Net operating loss
Total
100
S. Eur. Mid.Eur.
100
100
N.Eur.
100
36
5
41
59
31
5
36
64
30
4
34
66
45
6
51
49
12
2
33
5
52
7
18
3
35
7
63
1
7
2
30
4
43
23
16
2
35
4
57
(8)
N. Europe’s
contribution
margin is lower
5
3
8
(1)
problem 12-16
Part 3 – Segment reporting (Topic 8.8)
SOLUTION - In €s
Total
Sales
N. Europe is not 100
Less variable expenses:
covering
its
36
Cost of goods
sold
traceable
5
Shipping
expense costs
41
Total variable expenses
59
Contribution margin
Less traceable fixed exp.
12
Salaries
2
Insurance
33
Advertising
5
Depreciation
52
Total traceable fixed exp.
7
Territorial seg. margin
Less common fixed exp.
5
Advertising (gen.)
3
General admin.
8
Total common fixed exp.
(1)
Net operating loss
S. Eur. Mid.Eur
100
100.
N.Eur.
100
31
5
36
64
30
4
34
66
45
6
51
49
18
3
35
7
63
1
7
2
30
4
43
23
16
2
35
4
57
(8)
problem 12-16
MA1 – MODULE 8
Part 4
Revenue variance and
market expense
analysis
Topic 8.9
70
72
71
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
Analyze variances from revenue targets. (Level 1)
Static-budget
variances
Sales-volume
variance
Flexible-budget
variance
Price
variance
Efficiency
variance
Mix
Variance
Stop the audio, and turn
to handout 1, pages 6-9
Yield
Variance
73
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
Analyze variances from revenue targets. (Level 1)
Static-budget
variances
Flexible-budget
variance
Price
variance
Sales-volume
variance
Sales Mix
Variance
Sales Quantity
Variance
Market share
variance
Market size
variance
74
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
Parker Company sells desks, chairs, and wall units. The
following is the budget and the actual results for 2008.
Parker Co.
Per unit
Totals
2008 Budget Selling Variable Contribution
Sales Sales Contribution
price
cost
margin volume mix
margin
Desks
259
189
70
3185 65%
222,950
Chairs
87
50
37
980 20%
36,260
Wall units
185
95
90
735 15%
66,150
TOTAL
4900 100%
325,360
Parker Co.
2008 Actual
Desks
Chairs
Wall units
TOTAL
Per unit
Totals
Selling Variable Contribution Sales Sales Contribution
price
cost
margin volume mix
margin
255
180
75
2880 64%
216,000
85
45
40
990 22%
39,600
185
95
90
630 14%
56,700
4500 100%
312,300
75
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
Static-budget
variances
Flexible-budget
variance
Price
variance
Sales-volume
variance
Sales Mix
Variance
Sales Quantity
Variance
Market share
variance
Market size
variance
76
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
1. Prepare the static budget
Desks
Chairs
Wall units
TOTAL
Parker Co. - Static Budget
Actual
Static Static Budget
Variance
Results
Budget
734,400
824,915
90,515 U
84,150
85,260
1,110 U
116,550
135,975
19,425 U
935,100
1,046,150
111,050 U
How much of the variance is due to the fact
that they sold less and how much of it is due
to the fact that the selling price has changed?
77
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
78
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
2. Prepare the flexible budget
Parker Co.
Flexible and Sales volume variances
Actual
Flexible Flexible
Sales
Static
Results Budget/Price Budget
Volume
Budget
Variance
Variance
Desks
734,400
745,920
824,915
Chairs
84,150
86,130
85,260
Wall units
116,550
116,550
135,975
TOTAL
935,100
948,600
1,046,150
Desks
Chairs
Wall units
Bud.sell.price
$259 x
$87 x
$185 x
Act.units
2880 =
990 =
630 =
$745,920
$86,130
$116,550
79
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
2. Prepare the flexible budget
Parker Co.
Flexible and Sales volume variances
Actual
Flexible Flexible
Sales
Static
Results Budget/Price Budget
Volume
Budget
Variance
Variance
Desks
734,400
11,520U 745,920
78,995U
824,915
Chairs
84,150
1,980U
86,130
870 F
85,260
Wall units
116,550
0 116,550 19,425 U
135,975
TOTAL
935,100
13,500 U 948,600 97,550 U 1,046,150
Sales price variance
80
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
2. Prepare the flexible budget
Parker Co.
Flexible and Sales volume variances
Actual
Flexible Flexible
Sales
Static
Results Budget/Price Budget
Volume
Budget
Variance
Variance
Desks
734,400
11,520U 745,920
78,995U
824,915
Chairs
84,150
1,980U
86,130
870 F
85,260
Wall units 116,550
0 116,550 19,425 U
135,975
TOTAL
935,100
13,500 U 948,600 97,550 U 1,046,150
How much of this variance is due to a change in the sales
mix of the three products and how much of it is due to an
overall change in the number of units sold?
This next analysis will be based on contribution margin
81
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
Static-budget
variances
Flexible-budget
variance
Price
variance
Sales-volume
variance
Sales Mix
Variance
Sales Quantity
Variance
Market share
variance
Market size
variance
82
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
3. Prepare the sales mix and sales quantity variances
Parker Co.
Flexible and Sales volume variances
Actual
Flexible Flexible
Sales
Static
Results Budget/Price Budget
Volume
Budget
Variance
Variance
Desks
734,400
11,520U 745,920
78,995U
824,915
Chairs
84,150
1,980U
86,130
870 F
85,260
Wall units 116,550
0 116,550 19,425 U
135,975
TOTAL
935,100
13,500 U 948,600 97,550 U 1,046,150
Based on contribution margin:
Act.sls. CM
Desks:
2880 x $70 = $201,600
Chairs:
990 x $37 = $36,630
Wall units:
630 x $90 = $56,700
TOTAL
$294,930
$325,360
83
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
3. Prepare the sales mix and sales quantity variances
Parker Co.
Sales Mix and Sales Quantity Variances
Bud. Flexible Sls. mix Act. units
Sales Static
x bud. quantity budget
sls. budget variance
sls. mix x variance
mix
bud. CM
Desks
65% 201,600
204,750
222,950
Chairs
20% 36,630
33,300
36,260
Wall units
15% 56,700
60,750
66,150
TOTAL
100% 294,930
298,800
325,360
Desks: 4500 x 65% x $70= $204,750
Chairs 4500 x 20% x $37 =
$33,300
Wall units 4500 x 15% x $90 = $60,750
84
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
3. Prepare the sales mix and sales quantity variances
Parker Co.
Sales Mix and Sales Quantity Variances
Act. Bud. Flexible Sls. mix Act. units
Sales Static
x bud. quantity budget
sls. sls. budget variance
sls. mix x variance
mix mix
bud. CM
Desks
64% 65% 201,600 3,150U 204,750 18,200U 222,950
Chairs
22% 20% 36,630 3,330F
33,300 2,960U 36,260
Wall units 14% 15% 56,700 4,050U
60,750 5,400U 66,150
TOTAL
100% 100% 294,930 3,870U 298,800 26,560U 325,360
For desks the actual sales mix is 1% less
than the budgeted sales mix. 4500 total
units x 1% x CM of $70 per unit is $3,150.
85
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
3. Prepare the sales mix and sales quantity variances
Parker Co.
Sales Mix and Sales Quantity Variances
Act. Bud. Flexible Sls. mix Act. units
Sales Static
x bud. quantity budget
sls. sls. budget variance
sls. mix x variance
mix mix
bud. CM
Desks
64% 65% 201,600 3,150U 204,750 18,200U 222,950
Chairs
22% 20% 36,630 3,330F
33,300 2,960U 36,260
Wall units 14% 15% 56,700 4,050U
60,750 5,400U 66,150
TOTAL
100% 100% 294,930 3,870U 298,800 26,560U 325,360
In total 400 less units were sold (4,900
minus 4,500). Of that amount 65% were
desks. At a contribution margin level of
$70 that represents a 400 x .65 x $70 =
$18,200 unfavorable variance for desks.
86
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
3. Prepare the sales mix and sales quantity variances
Parker Co.
Sales Mix and Sales Quantity Variances
Act. Bud. Flexible Sls. mix Act. units
Sales Static
x bud. quantity budget
sls. sls. budget variance
sls. mix x variance
mix mix
bud. CM
Desks
64% 65% 201,600 3,150U 204,750 18,200U 222,950
Chairs
22% 20% 36,630 3,330F
33,300 2,960U 36,260
Wall units 14% 15% 56,700 4,050U
60,750 5,400U 66,150
TOTAL
100% 100% 294,930 3,870U 298,800 26,560U 325,360
How much of this variance is based on a
change of market share and how much
of it is a result of change in market size?
87
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
Static-budget
variances
Flexible-budget
variance
Price
variance
Sales-volume
variance
Sales Mix
Variance
Sales Quantity
Variance
Market share
variance
Market size
variance
88
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
Assume that Parker Co. derives its total unit sales budget for 2008
from a management estimate of a 20% market share and a total
industry sales forecast by DBM Services of 24,500 units in the
region. In 2003, DBM Services reported actual industry sales of
28,125 units. Prepare the market share and market size variances.
Parker Co. - Market share and Market Size Variances
Act. units x
Mkt. Actual mkt. size
Mkt.
Static
bud. sls.
share x bud. mkt. share
size budget
mix x bud. variance
x bud. average variance
CM
CM/unit
TOTAL
298,800
325,360
89
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
Assume that Parker Co. derives its total unit sales budget for 2008
from a management estimate of a 20% market share and a total
industry sales forecast by DBM Services of 24,500 units in the
region. In 2003, DBM Services reported actual industry sales of
28,125 units. Prepare the market share and market size variances.
Parker Co. - Market share and Market Size Variances
Act. units x
Mkt. Actual mkt. size
Mkt.
Static
bud. sls.
share x bud. mkt. share
size budget
mix x bud. variance
x bud. average variance
CM
CM/unit
TOTAL
298,800 74,700U
373,500 48,140F 325,360
Budgeted average CM:
Desks:
$70x3185units=$222,950
Chairs:
$37x980 units=$ 36,260
Wall units:
$90x735 units=$ 66,150
TOTAL
$325,360/4900 units=$66.40
90
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
Assume that Parker Co. derives its total unit sales budget for 2008
from a management estimate of a 20% market share and a total
industry sales forecast by DBM Services of 24,500 units in the
region. In 2003, DBM Services reported actual industry sales of
28,125 units. Prepare the market share and market size variances.
Parker Co. - Market share and Market Size Variances
Act. units x
Mkt. Actual mkt. size
Mkt.
Static
bud. sls.
share x bud. mkt. share
size budget
mix x bud. variance
x bud. average variance
CM
CM/unit
TOTAL
298,800 74,700U
373,500 48,140F 325,360
28,125 units x 20% mkt.share x $66.40 budgeted ave. CM/unit
91
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
Assume that Parker Co. derives its total unit sales budget for 2008
from a management estimate of a 20% market share and a total
industry sales forecast by DBM Services of 24,500 units in the
region. In 2003, DBM Services reported actual industry sales of
28,125 units. Prepare the market share and market size variances.
Parker Co. - Market share and Market Size Variances
Act. units x
Mkt. Actual mkt. size
Mkt.
Static
bud. sls.
share x bud. mkt. share
size budget
mix x bud. variance
x bud. average variance
CM
CM/unit
TOTAL
298,800 74,700U
373,500 48,140F 325,360
• Parker actually sold 4500 units in total
• Based on actual market results, Parker should have
sold 28,125 x 20% =5,625 units to maintain their 20%
share of the market. Instead they sold 4,500 units
• 5,625-4,500 units = 1,125 units x $66.40=$74,700 that
they lost of their market share
92
Part 4 – Revenue variance and marketing expense analysis
(Topic 8.9)
Assume that Parker Co. derives its total unit sales budget for 2008
from a management estimate of a 20% market share and a total
industry sales forecast by DBM Services of 24,500 units in the
region. In 2003, DBM Services reported actual industry sales of
28,125 units. Prepare the market share and market size variances.
Parker Co. - Market share and Market Size Variances
Act. units x
Mkt. Actual mkt. size
Mkt.
Static
bud. sls.
share x bud. mkt. share
size budget
mix x bud. variance
x bud. average variance
CM
CM/unit
TOTAL
298,800 74,700U
373,500 48,140F 325,360
• The total market size has increased by 28,12524,500=3,625 units
• Parker’s share of this is 20%x3,625 = 725 units
• 725 units x average CM of $66.40 is $48,140.
• This means that Parker’s share of the increase in
the market size is $48,140.
93
MA1 – MODULE 8
Part 5
Rate of return and
residual income
Topic 8.10
94
Part 5 – Rate of return and residual income (Topic 8.10)
Compute and interpret the return on investment and residual
income and list the strengths and weaknesses of each method.
(Level 1)
Measuring performance of
investment centres
Return on
investment
(ROI)
Net operating income
Sales
Margin
Management’s ability
to control expenses in
relation to sales
x
Sales
Average operating
assets
Turnover
Amount of sales
generated by the
investment in assets
95
Part 5 – Rate of return and residual income (Topic 8.10)
Compute and interpret the return on investment and residual
income and list the strengths and weaknesses of each method.
(Level 1)
Measuring performance of
investment centres
Advantages
Return on
investment • Percentages are easy to understand and
compare with other divisions/companies
(ROI)
• Forces control of investments in assets and costs
• Includes major ingredients of profitability
Disadvantages
• May encourage short run increases in ROI or
changes that are inconsistent with strategies
• A manager may not be able to control
committed costs
• Ignores product quality
• May reject profitable investment opportunities to
96
maximize ROI
Part 5 – Rate of return and residual income (Topic 8.10)
Compute and interpret the return on investment and residual
income and list the strengths and weaknesses of each method.
(Level 1)
Measuring performance of
investment centres
Residual
income
Net operating income – (minimum required
return on investments)
% return x average
investments
•Deducting the minimum required return leaves
the residual income available for investments.
97
Part 5 – Rate of return and residual income (Topic 8.10)
Compute and interpret the return on investment and residual
income and list the strengths and weaknesses of each method.
(Level 1)
Measuring performance of
investment centres
Residual
income
Advantages
• Includes major ingredients of profitability
• Encourages managers to make investments that
are profitable to the entire organization.
Disadvantages
• May encourage short run increases in RI
• Cannot compare with different size segments
• Not normally used by external analysts.
98
Part 5 – Rate of return and residual income (Topic 8.10)
Measuring performance of
investment centres
ROI APPROACH
Sales
Net operating income
Operating assets
ROI (margin x turnover)
Present
21,000,000
1,680,000
5,250,000
32%
New line
Total
(1,680,000/21,000,000) x (21,000,000/5,250,000)
(net operating income/sales) x (sales/average operating assets)
1. Compute the divisions ROI for last year, also, compute the
ROI as it will appear if the new product line is added.
Stop the audio, turn to page 594, problem 12-18
in the textbook and pages 9-10 of handout1.
99
Part 5 – Rate of return and residual income (Topic 8.10)
Measuring performance of
investment centres
ROI APPROACH
Sales
Net operating income
Operating assets
ROI (margin x turnover)
Present New line
21,000,000 9,000,000
1,680,000 630,000*
5,250,000 3,000,000
32%
21%
Total
(630,000/9,000,000) x (9,000,000/3,000,000)
(net operating income/sales) x (sales/average operating assets)
*(9,000,000-(65% of 9,000,000)-2,520,000)
1. Compute the divisions ROI for last year, also, compute the
ROI as it will appear if the new product line is added.
Problem 12-18, page 594
100
Part 5 – Rate of return and residual income (Topic 8.10)
Measuring performance of
investment centres
ROI APPROACH
Sales
Net operating income
Operating assets
ROI (margin x turnover)
Present New line
Total
21,000,000 9,000,000 30,000,000
1,680,000
630,000 2,310,000
5,250,000 3,000,000 8,250,000
32%
21%
28%
(2,310,000/30,000,000) x (30,000,000/8,250,000)
(net operating income/sales) x (sales/average operating assets)
1. Compute the divisions ROI for last year, also, compute the
ROI as it will appear if the new product line is added.
Problem 12-18, page 594
101
Part 5 – Rate of return and residual income (Topic 8.10)
Measuring performance of
investment centres
ROI APPROACH
Sales
Net operating income
Operating assets
ROI (margin x turnover)
Present New line
Total
21,000,000 9,000,000 30,000,000
1,680,000
630,000 2,310,000
5,250,000 3,000,000 8,250,000
32%
21%
28%
2. Fred has no incentive to accept the
investment if it will reduce his ROI from
32% to 28%.
3. Yet it will increase the company’s overall
ROI of 18%
Problem 12-18, page 594
102
Part 5 – Rate of return and residual income (Topic 8.10)
Measuring performance of
investment centres
RESIDUAL INCOME APPROACH
Net operating income
Minimum net operating income
Residual income
Present New line
$1,680,000
787,500
Total
$ 892,500
Operating assets x minimum rate of return
(5,250,000 x 15%)
4. a. Compute the East Division’s residual income for last
year, also compute the residual income as it will appear if
the new product line is added
Problem 12-18, page 594
103
Part 5 – Rate of return and residual income (Topic 8.10)
Measuring performance of
investment centres
RESIDUAL INCOME APPROACH
Net operating income
Minimum net operating income
Residual income
Present New line
$1,680,000 $ 630,000
787,500
450,000
Total
$ 892,500 $ 180,000
Operating assets x minimum rate of return
(3,000,000 x 15%)
4. a. Compute the East Division’s residual income for last
year, also compute the residual income as it will appear if
the new product line is added
Problem 12-18, page 594
104
Part 5 – Rate of return and residual income (Topic 8.10)
Measuring performance of
investment centres
RESIDUAL INCOME APPROACH
Net operating income
Minimum net operating income
Residual income
Present New line
Total
$1,680,000 $ 630,000 $2,310,000
787,500
450,000 1,237,500
$ 892,500 $ 180,000 $1,072,500
Operating assets x minimum rate of return
(8,250,000 x 15%)
4. a. Compute the East Division’s residual income for last
year, also compute the residual income as it will appear if
the new product line is added
Problem 12-18, page 594
105
Part 5 – Rate of return and residual income (Topic 8.10)
Measuring performance of
investment centres
RESIDUAL INCOME APPROACH
Net operating income
Minimum net operating income
Residual income
Present New line
Total
$1,680,000 $ 630,000 $2,310,000
787,500
450,000 1,237,500
$ 892,500 $ 180,000 $1,072,500
4.b. Using this approach, Fred is inclined to accept
the project because it will increase the East
Division’s residual income.
Problem 12-18, page 594
106
MA1 – MODULE 8
Part 6
Review question:
Variance analysis – working
backward from variance data
(download the additional questions handout:
ma1_mod8_handout1.pdf)
107
Part 6 – Review question: Variance analysis – working
backward from variance data
Case 11-27 pages 538-539
Handout page 11
1.
How many units were produced last period?
2.
How many metres of direct materials were
purchased and used?
3.
What was the actual cost per metre of material?
4.
How many actual direct labour hours were worked?
Stop the audio, read and attempt the
question in the textbook then come back to
listen to the solution.
108
Part 6 – Review question: Variance analysis – working
backward from variance data
Case 11-27 pages 538-539
Handout page 11
5.
What was the actual rate per direct labour hour?
6.
How much actual variable manufacturing overhead
cost was incurred?
7.
What is the total fixed manufacturing overhead
cost in the flexible budget?
8.
What were the denominator hours for last period?
109
MA1 – MODULE 8
Part 7
Review question:
Segmented statements;
Product-line analysis
(download the additional questions handout:
ma1_mod8_handout1.pdf)
110
Part 7 – Review question: Segmented statements
Case 12-31 pages 604-605
Handout pages 12 and 13
1.
Prepare a new income statement segmented by
product lines
2.
Do you agree with Aiken’s decision to cut back
production of line A?
3.
What points would you make for or against
elimination of line C?
Stop the audio, read and attempt the
question in the textbook then come back to
listen to the solution.
111
Part 7 – Review question: Segmented statements
Case 12-31 pages 604-605
Handout pages 12 and 13
4.
a. Prepare a segmented income statement showing
line C segmented by markets
b. What points revealed by this statement would
you want to bring to the attention of management?
112
MA1 – MODULE 8
Part 8
Review question:
Segmented statement analysis:
ROI and residual income
(download the additional questions handout:
ma1_mod8_handout1.pdf)
113
Part 8 – Review question: Segmented statement analysis:
ROI and residual income
Question 1 March, 1992 exam
Handout pages 14 thru 15
Q1 By employing as many different measures as you
can, demonstrate which of Divisions A, B, or C has
performed the best in 1991
Interpret the results
Stop the audio, read and attempt the
question in the handout then come back to
listen to the solution.
114
Part 8 – Review question: Segmented statement analysis:
ROI and residual income
Question 1 March, 1992 exam
Handout pages 14 thru 15
Q1 By employing as many different measures as you
can, demonstrate which of Divisions A, B, or C has
performed the best in 1991
Interpret the results
115
Part 8 – Review question: Segmented statement analysis:
ROI and residual income
Question 1 March, 1992 exam
Handout pages 14 thru 15
Q1 By employing as many different measures as you
can, demonstrate which of Divisions A, B, or C has
performed the best in 1991
Interpret the results
116
MA1 – MODULE 8
Part 9
Review questions:
Multiple Choice Questions
(download the additional questions handout:
ma1_mod8_handout1.pdf)
117
Part 9 – Review questions: Multiple choice
Multiple choice questions
Handout pages 16 thru 19
Now working on page 16
Q1 Which variances does DEF Manufacturing have?
Q2 What does this mean for the standard direct labour
hours allowed for April’s output?
Q3 What was the amount of overhead cost applied to
work in process for May?
Stop the audio, read and attempt the
question in the handout then come back to
listen to the solution.
118
Part 9 – Review questions: Multiple choice
Multiple choice questions
Handout pages 16 thru 19
Now working on page 17
Q4 a. What was the variable overhead efficiency
variance?
b. What was the fixed overhead production volume
variance?
Q5 What would be the total flexible budget if total lines
printed increased to 2,600,000?
119
Part 9 – Review questions: Multiple choice
Multiple choice questions
Handout pages 16 thru 19
Now working on page 18
Q6 What is the flexible budget for 40,000 and 20,000
units, respectively?
Q7 How does the application of JIT principles improve
return on investment?
Q8 What is the amount of invested capital?
Q9 What was Rai’s invested capital in 2002?
120
Part 9 – Review questions: Multiple choice
Multiple choice questions
Handout pages 16 thru 19
Now working on page 19
Q10 a. Which single note to the financial results would be
most appropriate in a report to management?
b. Which of the following would be the most
appropriate conclusion in the report to management?
121