11-1
MANAGERIAL
ACCOUNTING
Ninth Canadian Edition
GARRISON, CHESLEY, CARROLL, WEBB, LIBBY
Reporting for Control
Chapter 11
PowerPoint Author:
Robert G. Ducharme, MAcc, CA
University of Waterloo, School of Accounting and Finance
Copyright © 2012 McGraw-Hill Ryerson Limited
11-2
Decentralization in Organizations
Benefits of
Decentralization
Lower-level managers
gain experience in
decision-making.
Top management
freed to concentrate
on strategy.
Decision-making
authority leads to
job satisfaction.
Lower-level decisions
often based on
better information.
Lower level managers
can respond quickly
to customers.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-3
Decentralization in Organizations
Lower-level managers
may make decisions
without seeing the
“big picture.”
Lower-level manager’s
objectives may not
be those of the
organization.
Copyright © 2012 McGraw-Hill Ryerson Limited
May be a lack of
coordination among
autonomous
managers.
Disadvantages of
Decentralization
May be difficult to
spread innovative ideas
in the organization.
LO 1
11-4
Decentralization and Segment Reporting
A segment is any
part or activity of an
organization about
which a manager
seeks cost,
revenue, or profit
data. A segment
can be . . .
Copyright © 2012 McGraw-Hill Ryerson Limited
An Individual Store
Quick Mart
A Sales Territory
A Service Centre
LO 1
11-5
Superior Foods: Geographic Regions
Superior Foods Corporation
$500,000,000
Central
$75,000,000
Newfoundland
$120,000,000
Atlantic
$300,000,000
Nova Scotia
$45,000,000
Prairie
$70,000,000
New Brunswick
$85,0000,000
West Coast
$55,000,000
Prince Edward Island
$50,000,000
Superior Foods Corporation could segment its business
by geographic regions.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-6
Superior Foods: Customer Channel
Superior Foods Corporation
$500,000,000
Convenience Stores
$80,000,000
Supermarket Chain A
$85,000,000
Supermarket Chains
$280,000,000
Supermarket Chain B
$65,000,000
Wholesale Distributors
$100,000,000
Supermarket Chain C
$90,000,000
Drugstores
$40,000,000
Supermarket Chain D
$40,000,000
Superior Foods Corporation could segment its business
by customer channel.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-7
Keys to Segmented Income Statements
There are two keys to building
segmented income statements:
A contribution format should be used
because it separates fixed from variable
costs and it enables the calculation of a
contribution margin.
Traceable fixed costs should be separated
from common fixed costs to enable the
calculation of a segment margin.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-8
Identifying Traceable Fixed Costs
Traceable costs arise because of the existence
of a particular segment and would disappear
over time if the segment itself disappeared.
No computer
division means . . .
Copyright © 2012 McGraw-Hill Ryerson Limited
No computer
division manager.
LO 1
11-9
Identifying Common Fixed Costs
Common costs arise because of the overall
operation of the company and would not
disappear if any particular segment were
eliminated.
No computer
division but . . .
Copyright © 2012 McGraw-Hill Ryerson Limited
We still have a
company president.
LO 1
11-10
Traceable Costs Can Become Common Costs
It is important to realize that the traceable
fixed costs of one segment may be a
common fixed cost of another segment.
For example, the landing fee
paid to land an airplane at an
airport is traceable to the
particular flight, but it is not
traceable to first-class,
business-class, and
economy-class passengers.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-11
Segment Margin
Profits
The segment margin, which is computed by
subtracting the traceable fixed costs of a segment
from its contribution margin, is the best gauge of
the long-run profitability of a segment.
Copyright © 2012 McGraw-Hill Ryerson Limited
Time
LO 1
11-12
Traceable and Common Costs
Fixed
Costs
Traceable
Copyright © 2012 McGraw-Hill Ryerson Limited
Don’t allocate
common costs to
segments.
Common
LO 1
11-13
Activity-Based Costing
Activity-based costing can help identify how costs
shared by more than one segment are traceable to
individual segments.
Assume that three products, 9-inch, 12-inch, and 18-inch pipe, share 10,000
square feet of warehousing space, which is leased at a price of $4 per square
foot.
If the 9-inch, 12-inch, and 18-inch pipes occupy 1,000, 4,000, and 5,000 square
feet, respectively, then ABC can be used to trace the warehousing costs to the
three products as shown.
Pipe Products
9-inch
12-inch
18-inch
Total
Warehouse sq. ft.
1,000
4,000
5,000
10,000
Lease price per sq. ft. $
4 $
4 $
4 $
4
Total lease cost
$
4,000 $
16,000 $
20,000 $
40,000
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-14
Levels of Segmented Statements
Webber, Inc. has two divisions.
Webber, Inc.
Computer Division
Television Division
Let’s look more closely at the Television
Division’s income statement.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-15
Levels of Segmented Statements
Our approach to segment reporting uses the
contribution format.
Income Statement
Contribution Margin Format
Television Division
Sales
$ 300,000
Variable COGS
120,000
Other variable costs
30,000
Total variable costs
150,000
Contribution margin
150,000
Traceable fixed costs
90,000
Division margin
$ 60,000
Copyright © 2012 McGraw-Hill Ryerson Limited
Cost of goods
sold consists of
variable
manufacturing
costs.
Fixed and
variable costs
are listed in
separate
sections.
LO 1
11-16
Levels of Segmented Statements
Our approach to segment reporting uses the
contribution format.
Income Statement
Contribution Margin Format
Television Division
Sales
$ 300,000
Variable COGS
120,000
Other variable costs
30,000
Total variable costs
150,000
Contribution margin
150,000
Traceable fixed costs
90,000
Division margin
$ 60,000
Copyright © 2012 McGraw-Hill Ryerson Limited
Contribution margin
is computed by
taking sales minus
variable costs.
Segment margin
is Television’s
contribution
to profits.
LO 1
11-17
Levels of Segmented Statements
Sales
Variable costs
CM
Traceable FC
Division margin
Common costs
Net operating
income
Copyright © 2012 McGraw-Hill Ryerson Limited
Income Statement
Company
Television
$ 500,000
$ 300,000
230,000
150,000
270,000
150,000
170,000
90,000
100,000
$ 60,000
Computer
$ 200,000
80,000
120,000
80,000
$ 40,000
LO 1
11-18
Levels of Segmented Statements
Sales
Variable costs
CM
Traceable FC
Division margin
Common costs
Net operating
income
Copyright © 2012 McGraw-Hill Ryerson Limited
Income Statement
Company
Television
$ 500,000
$ 300,000
230,000
150,000
270,000
150,000
170,000
90,000
100,000
$ 60,000
25,000
$
75,000
Computer
$ 200,000
80,000
120,000
80,000
$ 40,000
Common costs should not
be allocated to the
divisions. These costs
would remain even if one
of the divisions were
eliminated.
LO 1
11-19
Traceable Costs Can Become Common Costs
As previously mentioned, fixed costs that are
traceable to one segment can become
common if the company is divided into
smaller segments.
Let’s see how this works
using the Webber, Inc.
example!
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-20
Traceable Costs Can Become Common Costs
Webber’s Television Division
Television
Division
Regular
Big Screen
Product
Lines
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-21
Traceable Costs Can Become Common Costs
Income Statement
Television
Division
Regular
Sales
$ 200,000
Variable costs
95,000
CM
105,000
Traceable FC
45,000
Product line margin
$ 60,000
Common costs
Divisional margin
Big Screen
$ 100,000
55,000
45,000
35,000
$ 10,000
We obtained the following information from
the Regular and Big Screen segments.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-22
Traceable Costs Can Become Common Costs
Income Statement
Television
Division
Regular
Sales
$ 300,000
$ 200,000
Variable costs
150,000
95,000
CM
150,000
105,000
Traceable FC
80,000
45,000
Product line margin
70,000
$ 60,000
Common costs
10,000
Divisional margin
$ 60,000
Big Screen
$ 100,000
55,000
45,000
35,000
$ 10,000
Fixed costs directly traced
to the Television Division
$80,000 + $10,000 = $90,000
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-23
Segment Reporting for Financial Accounting
The Accounting Standards Board now requires that
companies in Canada include segmented financial data in
their annual reports.
1.
Companies must report segmented
results to shareholders using the same
methods that are used for internal
segmented reports.
2.
Since the contribution approach to
segment reporting does not comply
with GAAP, it is likely that some
managers will choose to construct
their segmented financial statements
using the absorption approach to
comply with GAAP.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-24
Hindrances to Proper Cost Assignment
Some Problems
Omission of some
costs in the
assignment process.
Assignment to segments
of costs that are
really common costs of
the entire organization.
Use of inappropriate
methods for allocating
costs among segments.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-25
Omission of Costs
Costs assigned to a segment should include all
costs attributable to that segment from the
company’s entire value chain.
Business Functions
Making Up The
Value Chain
R&D
Product
Design
Copyright © 2012 McGraw-Hill Ryerson Limited
Customer
Manufacturing Marketing Distribution Service
LO 1
Inappropriate Methods of Allocating Costs
Among Segments
Failure to trace
costs directly
Segment
1
Copyright © 2012 McGraw-Hill Ryerson Limited
Segment
2
11-26
Inappropriate
allocation base
Segment
3
Segment
4
LO 1
11-27
Arbitrarily Dividing Common Costs and Segments
Common costs should not be arbitrarily allocated to segments
based on the rationale that “someone has to cover the
common costs” for two reasons:
1. This practice may make a profitable business segment appear
to be unprofitable.
2. Allocating common fixed costs forces managers to be held
accountable for costs they cannot control.
Segment
1
Copyright © 2012 McGraw-Hill Ryerson Limited
Segment
2
Segment
3
Segment
4
LO 1
11-28
Quick Check 
Sales
Variable costs
CM
Traceable FC
Segment margin
Common costs
Profit
Income Statement
Haglund's
Bar
Lakeshore
$ 100,000
$ 800,000
60,000
310,000
40,000
490,000
26,000
246,000
$ 14,000
244,000
200,000
$ 44,000
Restaurant
$ 700,000
250,000
450,000
220,000
$ 230,000
Assume that Hagland's Lakeshore prepared its
segmented income statement as shown.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-29
Quick Check 
How much of the common fixed cost of
$200,000 can be avoided by eliminating the
bar?
a. None of it.
b. Some of it.
c. All of it.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-30
Quick Check 
How much of the common fixed cost of
$200,000 can be avoided by eliminating the
bar?
a. None of it.
b. Some of it.
c. All of it.
A common fixed cost cannot
be eliminated by dropping one
of the segments.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-31
Quick Check 
Suppose square feet is used as the basis for
allocating the common fixed cost of $200,000.
How much would be allocated to the bar if the
bar occupies 1,000 square feet and the
restaurant 9,000 square feet?
a. $20,000
b. $30,000
c. $40,000
d. $50,000
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-32
Quick Check 
Suppose square feet is used as the basis for
allocating the common fixed cost of $200,000.
How much would be allocated to the bar if the
bar occupies 1,000 square feet and the
restaurant 9,000 square feet?
a. $20,000
The bar would be
b. $30,000
allocated 1/10 of the cost
c. $40,000
or $20,000.
d. $50,000
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-33
Quick Check 
If Hagland's allocates its common
costs to the bar and the restaurant,
what would be the reported profit of
each segment?
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-34
Allocations of Common Costs
Sales
Variable costs
CM
Traceable FC
Segment margin
Common costs
Profit
Income Statement
Haglund's
Lakeshore
Bar
$ 800,000
$ 100,000
310,000
60,000
490,000
40,000
246,000
26,000
244,000
14,000
200,000
20,000
$ 44,000
$
(6,000)
Restaurant
$ 700,000
250,000
450,000
220,000
230,000
180,000
$ 50,000
Hurray, now everything adds up!!!
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-35
Quick Check 
Should the bar be eliminated?
a. Yes
b. No
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 1
11-36
Quick Check 
Should the bar be eliminated?
a. Yes
The profit was $44,000 before
b. No
eliminating the bar. If we eliminate
the bar,
profit drops to $30,000!
Income
Statement
Sales
Variable costs
CM
Traceable FC
Segment margin
Common costs
Profit
Copyright © 2012 McGraw-Hill Ryerson Limited
Haglund's
Lakeshore
$ 700,000
250,000
450,000
220,000
230,000
200,000
$ 30,000
Bar
Restaurant
$ 700,000
250,000
450,000
220,000
230,000
200,000
$ 30,000
LO 1
11-37
Cost, Profit, and Investments centres
Cost
centre
Profit
centre
Investment
centre
Cost, profit,
and investment
centres are all
Responsibility
known as
centre
responsibility
centres.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 2
11-38
Cost centre
A segment whose
manager has control
over costs,
but not over revenues
or investment funds.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 2
11-39
Profit centre
A segment whose
manager has control
over both costs and
revenues,
but no control over
investment funds.
Revenues
Sales
Interest
Other
Costs
Mfg. costs
Commissions
Salaries
Other
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 2
11-40
Investment centre
Corporate Headquarters
A segment whose
manager has control
over costs,
revenues, and
investments in
operating assets.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 2
11-41
Responsibility centres
Investment
Centres
Operations
Vice President
Salty Snacks
Product Manger
Bottling Plant
Manager
Beverages
Product Manager
Warehouse
Manager
Superior Foods Corporation
Corporate Headquarters
President and CEO
Finance
Chief FInancial Officer
Legal
General Counsel
Personnel
Vice President
Confections
Product Manager
Distribution
Manager
Cost
Centres
Superior Foods Corporation provides an example of the
various kinds of responsibility centres that exist in an
organization.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 2
11-42
Responsibility centres
Superior Foods Corporation
Corporate Headquarters
President and CEO
Operations
Vice President
Salty Snacks
Product Manger
Bottling Plant
Manager
Beverages
Product Manager
Warehouse
Manager
Finance
Chief FInancial Officer
Legal
General Counsel
Personnel
Vice President
Confections
Product Manager
Distribution
Manager
Profit
Centres
Superior Foods Corporation provides an example of the
various kinds of responsibility centres that exist in an
organization.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 2
11-43
Responsibility centres
Superior Foods Corporation
Corporate Headquarters
President and CEO
Operations
Vice President
Salty Snacks
Product Manger
Bottling Plant
Manager
Beverages
Product Manager
Warehouse
Manager
Finance
Chief FInancial Officer
Legal
General Counsel
Personnel
Vice President
Confections
Product Manager
Distribution
Manager
Cost
Centres
Superior Foods Corporation provides an example of the
various kinds of responsibility centres that exist in an
organization.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 2
11-44
Key Concepts/Definitions
A transfer price is the price
charged when one segment of
a company provides goods or
services to another segment of
the company.
The fundamental objective in
setting transfer prices is to
motivate managers to act in the
best interests of the overall
company.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 3
11-45
Three Primary Approaches
There are three primary
approaches to setting
transfer prices:
1. Negotiated transfer prices;
2. Transfers at the cost to the
selling division; and
3. Transfers at market price.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 3
11-46
Negotiated Transfer Prices
A negotiated transfer price results from discussions
between the selling and buying divisions.
Advantages of negotiated transfer prices:
1.
They preserve the autonomy of the
divisions, which is consistent with
the spirit of decentralization.
2.
The managers negotiating the
transfer price are likely to have much
better information about the potential
costs and benefits of the transfer
than others in the company.
Copyright © 2012 McGraw-Hill Ryerson Limited
Range of Acceptable
Transfer Prices
Upper limit is
determined by the
buying division.
Lower limit is
determined by the
selling division.
LO 3
11-47
Harrison Ltd – An Example
Assume the information as shown with
respect to Cumberland Beverages and Pizza
Place (both companies are owned by Harrison
Ltd).
Cumberland Beverages:
Ginger beer production capactiy per month
Variable cost per barrel of ginger beer
Fixed costs per month
Selling price of Imperial Beverages ginger beer
on the outside market
Pizza Place:
Purchase price of regular brand of ginger beer
Monthly comsumption of ginger beer
Copyright © 2012 McGraw-Hill Ryerson Limited
10,000 barrels
$ 8 per barrel
$ 70,000
$ 20 per barrel
$ 18 per barrel
2,000 barrels
LO 3
11-48
Harrison Ltd – An Example
The selling division’s (Cumberland Beverages) lowest acceptable transfer
price is calculated as:
Transfer Price 
Variable cost
Total contribution margin on lost sales
+
per unit
Number of units transferred
Let’s calculate the lowest and highest acceptable
transfer prices under three scenarios.
The buying division’s (Pizza Place) highest acceptable transfer price is
calculated as:
Transfer Price  Cost of buying from outside supplier
If an outside supplier does not exist, the highest acceptable transfer price
is calculated as:
Transfer Price  Profit to be earned per unit sold (not including the transfer price)
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 3
11-49
Harrison Ltd – An Example
If Cumberland Beverages has sufficient idle capacity (3,000 barrels) to satisfy
Pizza Place’s demands (2,000 barrels), without sacrificing sales to other
customers, then the lowest and highest possible transfer prices are
computed as follows:
Selling division’s lowest possible transfer price:
Transfer Price  $8 +
$0
= $8
2,000
Buying division’s highest possible transfer price:
Transfer Price  Cost of buying from outside supplier =
$18
Therefore, the range of acceptable
transfer price is $8 – $18.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 3
11-50
Harrison Ltd – An Example
If Cumberland Beverages has no idle capacity (0 barrels) and must sacrifice
other customer orders (2,000 barrels) to meet Pizza Place’s demands (2,000
barrels), then the lowest and highest possible transfer prices are computed
as follows:
Selling division’s lowest possible transfer price:
( $20 - $8) × 2,000
Transfer Price  $8 +
= $20
2,000
Buying division’s highest possible transfer price:
Transfer Price  Cost of buying from outside supplier
= $18
Therefore, there is no range of
acceptable transfer prices.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 3
11-51
Harrison Ltd – An Example
If Cumberland Beverages has some idle capacity (1,000 barrels) and must
sacrifice other customer orders (1,000 barrels) to meet Pizza Place’s
demands (2,000 barrels), then the lowest and highest possible transfer prices
are computed as follows:
Selling division’s lowest possible transfer price:
( $20 - $8) × 1,000
Transfer Price  $8 +
= $14
2,000
Buying division’s highest possible transfer price:
Transfer Price  Cost of buying from outside supplier
= $18
Therefore, the range of acceptable
transfer price is $14 – $18.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 3
11-52
Evaluation of Negotiated Transfer Prices
If a transfer within a company would result
in higher overall profits for the company,
there is always a range of transfer prices
within which both the selling and buying
divisions would have higher profits if they
agree to the transfer.
If managers are pitted against each other
rather than against their past
performance or reasonable benchmarks,
a no cooperative atmosphere is almost
guaranteed.
Given the disputes that often accompany
the negotiation process, most companies
rely on some other means of setting
transfer prices.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 3
11-53
Transfers at the Cost to the Selling Division
Many companies set transfer prices at either
the variable cost or full (absorption) cost
incurred by the selling division.
Drawbacks of this approach include:
1. Using full cost as a transfer price
and can lead to suboptimization.
2. The selling division will never
show a profit on any internal
transfer.
3. Cost-based transfer prices do not
provide incentives to control
costs.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 3
11-54
Transfers at Market Price
A market price (i.e., the price charged for an
item on the open market) is often regarded as
the best approach to the transfer pricing
problem.
1. A market price approach works
best when the product or service
is sold in its present form to
outside customers and the
selling division has no idle
capacity.
2. A market price approach does
not work well when the selling
division has idle capacity.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 3
11-55
Divisional Autonomy and Sub optimization
The principles of
decentralization suggest
that companies should
grant managers autonomy
to set transfer prices and
to decide whether to sell
internally or externally,
even if this may
occasionally result in
suboptimal decisions.
This way top management
allows subordinates to
control their own destiny.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 3
11-56
International Aspects of Transfer Pricing
Transfer Pricing
Objectives
Domestic
• Greater divisional autonomy
• Greater motivation for managers
• Better performance evaluation
• Better goal congruence
Copyright © 2012 McGraw-Hill Ryerson Limited
International
• Less taxes, duties, and tariffs
• Less foreign exchange risks
• Better competitive position
• Better governmental relations
LO 3
11-57
Return on Investment (ROI) Formula
Income before interest
and taxes (EBIT)
Operating income
ROI =
Average operating assets
Cash, accounts receivable, inventory,
plant and equipment, and other
productive assets.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 4
11-58
Net Book Value vs. Gross Cost
Most companies use the net book value of
depreciable assets to calculate average
operating assets.
Acquisition cost
Less: Accumulated depreciation
Net book value
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 4
11-59
Understanding ROI
Operating income
ROI =
Average operating assets
Margin =
Operating income
Sales
Sales
Turnover =
Average operating assets
ROI = Margin  Turnover
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 4
11-60
Increasing ROI
There are three ways to increase ROI . . .
Increase
Sales
Copyright © 2012 McGraw-Hill Ryerson Limited
Reduce
Operating
Expenses
Reduce
Operating
Assets
LO 4
11-61
Increasing ROI – An Example
Regal Company reports the following:
Operating income
Average operating assets
Sales
Operating expenses
$ 30,000
$ 200,000
$ 500,000
$ 470,000
What is Regal Company’s ROI?
ROI = Margin  Turnover
ROI =
Operating income
Sales
Copyright © 2012 McGraw-Hill Ryerson Limited
×
Sales
Average operating assets
LO 4
11-62
Increasing ROI – An Example
ROI = Margin  Turnover
ROI =
Operating income
Sales
$30,000
ROI =
$500,000
×
×
Sales
Average operating assets
$500,000
$200,000
ROI = 6%  2.5 = 15%
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 4
Increasing Sales Without an Increase in Operating
Assets

Regal's manager was able to increase sales to
$600,000, while operating expenses increased to
$558,000.

Regal's operating income increased to $42,000.

There was no change in the average operating
assets of the segment.
11-63
Let’s calculate the new ROI.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 4
Increasing Sales Without an Increase in Operating
Assets
11-64
ROI = Margin  Turnover
ROI =
Operating income
Sales
ROI = $42,000
$600,000
×
×
Sales
Average operating assets
$600,000
$200,000
ROI = 7%  3.0 = 21%
ROI increased from 15% to 21%.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 4
Decreasing Operating Expenses with no Change in Sales
or Operating Assets
11-65
Assume that Regal's manager was able to reduce
operating expenses by $10,000, without
affecting sales or operating assets. This would
increase operating income to $40,000.
Regal Company reports the following:
Operating income
Average operating assets
Sales
Operating expenses
$ 40,000
$ 200,000
$ 500,000
$ 460,000
Let’s calculate the new ROI.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 4
Decreasing Operating Expenses with no Change in Sales
or Operating Assets
11-66
ROI = Margin  Turnover
ROI =
Operating income
Sales
ROI = $40,000
$500,000
×
×
Sales
Average operating assets
$500,000
$200,000
ROI = 8%  2.5 = 20%
ROI increased from 15% to 20%.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 4
Decreasing Operating Assets with no Change in
Sales or Operating Expenses
11-67
Assume that Regal's manager was able to reduce
inventories by $20,000 using just-in-time
techniques, without affecting sales or operating
expenses.
Regal Company reports the following:
Operating income
Average operating assets
Sales
Operating expenses
$ 30,000
$ 180,000
$ 500,000
$ 470,000
Let’s calculate the new ROI.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 4
Decreasing Operating Assets with no Change in
Sales or Operating Expenses
11-68
ROI = Margin  Turnover
ROI =
Operating income
Sales
ROI = $30,000
$500,000
×
×
Sales
Average operating assets
$500,000
$180,000
ROI = 6%  2.78 = 16.7%
ROI increased from 15% to 16.7%.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 4
11-69
Investing in Operating Assets to Increase Sales
Assume that Regal's manager invests in a
$30,000 piece of equipment that increases sales
by $35,000, while increasing operating
expenses by $15,000.
Regal Company reports the following:
Operating income
Average operating assets
Sales
Operating expenses
$ 50,000
$ 230,000
$ 535,000
$ 485,000
Let’s calculate the new ROI.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 4
11-70
Investing in Operating Assets to Increase Sales
ROI = Margin  Turnover
ROI =
Operating income
Sales
ROI = $50,000
$535,000
×
×
Sales
Average operating assets
$535,000
$230,000
ROI = 9.35%  2.33 = 21.8%
ROI increased from 15% to 21.8%.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 4
11-71
Criticisms of ROI
In the absence of the balanced
scorecard, management may
not know how to increase ROI.
Managers often inherit many
committed costs over which
they have no control.
Managers evaluated on ROI
may reject profitable
investment opportunities.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 4
Residual Income - Another Measure of
Performance
11-72
Operating income
above some minimum
return on operating
assets
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-73
Calculating Residual Income
Residual
=
income
Operating
–
income
(
Average
operating
assets

)
Minimum
required rate of
return
This computation differs from ROI.
ROI measures operating income earned relative to
the investment in average operating assets.
Residual income measures operating income
earned less the minimum required return on
average operating assets.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-74
Residual Income – An Example
The Retail Division of Zephyr, Inc. has
average operating assets of $100,000
and is required to earn a return of 20%
on these assets.
In the current period, the division earns
$30,000.
Let’s calculate residual income.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-75
Residual Income – An Example
Operating assets
$ 100,000
Required rate of return ×
20%
Minimum required return $ 20,000
Actual income
Minimum required return
Residual income
Copyright © 2012 McGraw-Hill Ryerson Limited
$ 30,000
(20,000)
$ 10,000
LO 5
11-76
Motivation and Residual Income
Residual income encourages managers to
make profitable investments that would
be rejected by managers using ROI.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-77
Quick Check 
Redmond Awnings, a division of Wrap-up
Corp., has an operating income of $60,000
and average operating assets of $300,000.
The required rate of return for the company is
15%. What is the division’s ROI?
a. 25%
b. 5%
c. 15%
d. 20%
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-78
Quick Check 
Redmond Awnings, a division of Wrap-up
Corp., has an operating income of $60,000
and average operating assets of $300,000.
The required rate of return for the company is
15%. What is the division’s ROI?
a. 25%
b. 5%
c. 15% ROI = OI / Average operating assets
= $60,000 / $300,000 = 20%
d. 20%
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-79
Quick Check 
Redmond Awnings, a division of Wrap-up
Corp., has an operating income of $60,000
and average operating assets of $300,000. If
the manager of the division is evaluated
based on ROI, will she want to make an
investment of $100,000 that would generate
additional operating income of $18,000 per
year?
a. Yes
b. No
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-80
Quick Check 
Redmond Awnings, a division of Wrap-up
Corp., has an operating income of $60,000
and average operating assets of $300,000. If
the manager of the division is evaluated
based on ROI, will she want to make an
investment of $100,000 that would generate
additional operating income of $18,000 per
year?
ROI = $78,000/$400,000 = 19.5%
a. Yes
This lowers the division’s ROI from
b. No
20.0% down to 19.5%.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-81
Quick Check 
The company’s required rate of return is 15%.
Would the company want the manager of the
Redmond Awnings division to make an
investment of $100,000 that would generate
additional operating income of $18,000 per
year?
a. Yes
b. No
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-82
Quick Check 
The company’s required rate of return is 15%.
Would the company want the manager of the
Redmond Awnings division to make an
investment of $100,000 that would generate
additional operating income of $18,000 per
year?
ROI = $18,000 / $100,000 = 18%
a. Yes
The return on the investment
b. No
exceeds the minimum required rate
of return.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-83
Quick Check 
Redmond Awnings, a division of Wrap-up
Corp., has an operating income of $60,000
and average operating assets of $300,000.
The required rate of return for the
company is 15%. What is the division’s
residual income?
a. $240,000
b. $ 45,000
c. $ 15,000
d. $ 51,000
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-84
Quick Check 
Redmond Awnings, a division of Wrap-up
Corp., has an operating income of $60,000
and average operating assets of $300,000.
The required rate of return for the
company is 15%. What is the division’s
residual income?
a. $240,000
income
$60,000
b. $ 45,000 Operating
Required return (15% of $300,000)
(45,000)
$15,000
c. $ 15,000 Residual income
d. $ 51,000
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-85
Quick Check 
If the manager of the Redmond Awnings
division is evaluated based on residual
income, will she want to make an
investment of $100,000 that would
generate additional operating income of
$18,000 per year?
a. Yes
b. No
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-86
Quick Check 
If the manager of the Redmond Awnings
division is evaluated based on residual
income, will she want to make an
investment of $100,000 that would
generate additional operating income of
$18,000 per year?
a. Yes Operating income
$78,000
Required return (15% of $400,000)
(60,000)
b. No Residual income
$18,000
Yields an increase of $3,000 in the residual income.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-87
Divisional Comparisons and Residual Income
The residual
income approach
has one major
disadvantage.
It cannot be used to
compare
performance of
divisions of
different sizes.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-88
Zephyr, Inc. – Continued
Recall the following
information for the Retail
Division of Zephyr, Inc.
Assume the following
information for the Wholesale
Division of Zephyr, Inc.
Retail
Wholesale
Operating assets
$ 100,000 $ 1,000,000
Required rate of return ×
20%
20%
Minimum required return $ 20,000 $ 200,000
Retail
Wholesale
Actual income
$ 30,000 $ 220,000
Minimum required return
(20,000)
(200,000)
Residual income
$ 10,000 $
20,000
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-89
Zephyr, Inc. – Continued
The residual income numbers suggest that the Wholesale Division outperformed
the Retail Division because its residual income is $10,000 higher. However, the
Retail Division earned an ROI of 30% compared to an ROI of 22% for the
Wholesale Division. The Wholesale Division’s residual income is larger than the
Retail Division simply because it is a bigger division.
Retail
Wholesale
Operating assets
$ 100,000 $ 1,000,000
Required rate of return ×
20%
20%
Minimum required return $ 20,000 $ 200,000
Retail
Wholesale
Actual income
$ 30,000 $ 220,000
Minimum required return
(20,000)
(200,000)
Residual income
$ 10,000 $
20,000
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-90
Criticisms of Residual Income
RI is based on historical accounting
data which can lead to inflated
amounts for residual income in
periods of rising prices (i.e.. values
for capital assets).
RI does not indicate what earnings
should be (need comparison of
external benchmark or trends).
Calculating RI requires numerous
adjustments to GAAP increasing
the cost of preparing information.
RI does not incorporate important
leading non-financial indicators.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 5
11-91
The Balanced Scorecard
Management translates its strategy into
performance measures that employees
understand and accept.
Customers
Financial
Performance
measures
Internal
business
processes
Copyright © 2012 McGraw-Hill Ryerson Limited
Learning
and growth
LO 6
The Balanced Scorecard:
From Strategy to Performance Measures
Exhibit
11-4
11-92
Performance Measures
Financial
Has our financial
performance improved?
Customer
Do customers recognize that
we are delivering more value?
Internal Business Processes
Have we improved key business
processes so that we can deliver
more value to customers?
What are our
financial goals?
What customers do
we want to serve and
how are we going to
win and retain them?
Vision
and
Strategy
What internal business processes are
critical to providing
value to customers?
Learning and Growth
Are we maintaining our ability
to change and improve?
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
The Balanced Scorecard:
Non-financial Measures
11-93
The balanced scorecard relies on non-financial measures
in addition to financial measures for two reasons:
 Financial measures are lag indicators that summarize
the results of past actions. Non-financial measures are
leading indicators of future financial performance.
 Top managers are ordinarily responsible for financial
performance measures – not lower level managers.
Non-financial measures are more likely to be
understood and controlled by lower level managers.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
11-94
The Balanced Scorecard for Individuals
The entire organization
should have an overall
balanced scorecard.
Each individual should
have a personal
balanced scorecard.
A personal scorecard should contain measures that can be
influenced by the individual being evaluated and that
support the measures in the overall balanced scorecard.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
11-95
The Balanced Scorecard
A balanced scorecard should have measures
that are linked together on a cause-and-effect basis.
If we improve
one performance
measure . . .
Then
Another desired
performance measure
will improve.
The balanced scorecard lays out concrete
actions to attain desired outcomes.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
The Balanced Scorecard
and Compensation
11-96
Incentive compensation
should be linked to
balanced scorecard
performance measures.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
11-97
The Balanced Scorecard
Jaguar Example
Profit
Financial
Contribution per car
Number of cars sold
Customer
Customer satisfaction
with options
Internal
Business
Processes
Number of
options available
Learning
and Growth
Copyright © 2012 McGraw-Hill Ryerson Limited
Time to
install option
Employee skills in
installing options
LO 6
11-98
The Balanced Scorecard
Jaguar Example
Profit
Contribution per car
Number of cars sold
Customer satisfaction
with options
Results
Satisfaction
Increases
Strategies
Increase
Options
Number of
options available
Increase
Skills
Copyright © 2012 McGraw-Hill Ryerson Limited
Time to
install option
Time
Decreases
Employee skills in
installing options
LO 6
11-99
The Balanced Scorecard
Jaguar Example
Profit
Contribution per car
Results
Number of cars sold
Customer satisfaction
with options
Number of
options available
Cars sold
Increase
Satisfaction
Increases
Time to
install option
Employee skills in
installing options
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
11-100
The Balanced Scorecard
Jaguar Example
Profit
Results
Contribution per car
Contribution
Increases
Number of cars sold
Customer satisfaction
with options
Number of
options available
Time to
install option
Satisfaction
Increases
Time
Decreases
Employee skills in
installing options
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
11-101
The Balanced Scorecard
Jaguar Example
Results
Profit
If number
of cars sold
and contribution
per car increase,
profits
increase.
Profits
Increase
Contribution per car
Contribution
Increases
Number of cars sold
Cars Sold
Increases
Customer satisfaction
with options
Number of
options available
Time to
install option
Employee skills in
installing options
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
11-102
Advantages of Graphic Feedback
Tim e to Install an Option
Time to Install in Minutes
35
30
25
20
15
10
5
0
1
2
3
4
5
6
7
8
9
10
Week
When interpreting its performance, Jaguar will look for
continual improvement. It is easier to spot trends or
unusual performance if these data are presented
graphically.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
11-103
Delivery Performance Measures
Order
Received
Wait Time
Production
Started
Goods
Shipped
Process Time + Inspection Time
+ Move Time + Queue Time
Throughput Time
Delivery Cycle Time
Process time is the only value-added time.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
11-104
Delivery Performance Measures
Order
Received
Wait Time
Production
Started
Goods
Shipped
Process Time + Inspection Time
+ Move Time + Queue Time
Throughput Time
Delivery Cycle Time
Manufacturing
Cycle
=
Efficiency
Copyright © 2012 McGraw-Hill Ryerson Limited
Value-added time
Manufacturing cycle time
LO 6
11-105
Quick Check 
A TQM team at Narton Corp has recorded the
following average times for production:
Wait
3.0 days
Inspection 0.4 days
Process 0.2 days
Move 0.5 days
Queue 9.3 days
What is the throughput time?
a. 10.4 days
b. 0.2 days
c. 4.1 days
d. 13.4 days
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
11-106
Quick Check 
A TQM team at Narton Corp has recorded the
following average times for production:
Wait
3.0 days
Inspection 0.4 days
Process 0.2 days
Move 0.5 days
Queue 9.3 days
What is the throughput time?
a. 10.4 days
b. 0.2 time
days= Process + Inspection + Move + Queue
Throughput
c. 4.1 days= 0.2 days + 0.4 days + 0.5 days + 9.3 days
d. 13.4 days= 10.4 days
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
11-107
Quick Check 
A TQM team at Narton Corp has recorded the
following average times for production:
Wait
3.0 days
Inspection 0.4 days
Process 0.2 days
Move 0.5 days
Queue 9.3 days
What is the Manufacturing Cycle Efficiency?
a. 50.0%
b. 1.9%
c. 52.0%
d. 5.1%
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
11-108
Quick Check 
A TQM team at Narton Corp has recorded the
following average times for production:
Wait
3.0 days
Inspection 0.4 days
Process 0.2 days
Move 0.5 days
Queue 9.3 days
What is the Manufacturing Cycle Efficiency?
a. 50.0%
b. 1.9%
c. 52.0%
d. 5.1%
Copyright © 2012 McGraw-Hill Ryerson Limited
MCE = Value-added time ÷ Throughput time
= Process time ÷ Throughput time
= 0.2 days ÷ 10.4 days
= 1.9%
LO 6
11-109
Quick Check 
A TQM team at Narton Corp has recorded the
following average times for production:
Wait
3.0 days
Inspection 0.4 days
Process 0.2 days
Move 0.5 days
Queue 9.3 days
What is the delivery cycle time?
a. 0.5 days
b. 0.7 days
c. 13.4 days
d. 10.4 days
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
11-110
Quick Check 
A TQM team at Narton Corp has recorded the
following average times for production:
Wait
3.0 days
Inspection 0.4 days
Process 0.2 days
Move 0.5 days
Queue 9.3 days
What is the delivery cycle time?
a. 0.5 days Delivery cycle time
b. 0.7 days
= Wait time + Throughput time
= 3.0 days + 10.4 days
c. 13.4 days
= 13.4 days
d. 10.4 days
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
11-111
ROI and the Balanced Scorecard
It may not be obvious to managers how to increase
sales, decrease costs, and decrease investments in a
way that is consistent with the company’s strategy. A
well constructed balanced scorecard can provide
managers with a road map that indicates how the
company intends to increase ROI.
Which internal business
process should be
improved?
Which customers should
be targeted and how will
they be attracted and
retained at a profit?
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 6
11-112
Quality of Conformance
When the overwhelming majority of
products produced conform to design
specifications and are free from
defects.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 7
11-113
Prevention and Appraisal Costs
Prevention
Costs
Support activities
whose purpose is to
reduce the number of
defects
Appraisal Costs
Incurred to identify
defective products
before the products are
shipped
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 7
11-114
Internal and External Failure Costs
Internal Failure
Costs
Incurred as a result of
identifying defects
before they are shipped
External Failure
Costs
Incurred as a result of
defective products
being delivered to
customers
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 7
11-115
Examples of Quality Costs
Prevention Costs
• Quality training
• Quality circles
• Statistical process
control activities
Internal Failure Costs
• Scrap
• Spoilage
• Rework
Copyright © 2012 McGraw-Hill Ryerson Limited
Appraisal Costs
• Testing & inspecting
incoming materials
• Final product testing
• Depreciation of testing
equipment
External Failure Costs
• Cost of field servicing &
handling complaints
• Warranty repairs
• Lost sales
LO 7
11-116
Distribution of Quality Costs
When quality of conformance is low, total
quality cost is high and consists mostly of
internal and external failure.
Total quality costs drop rapidly as the quality
of conformance increases.
Companies reduce their total quality costs by
focusing their efforts on prevention and
appraisal because the cost savings from
reduced defects usually overwhelm the
costs of additional prevention and
appraisal.
Total quality costs are minimized when the
quality of conformance is slightly less
than 100%.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 7
Quality Cost Report
For Years 1 and 2
Year 2
Amount
Percent*
Prevention costs:
Systems development
Quality training
Supervision of prevention activities
Quality improvement
Total prevention cost
400,000
210,000
70,000
320,000
1,000,000
0.80% $
0.42%
0.14%
0.64%
2.00%
Appraisal costs:
Inspection
Reliability testing
Supervision of testing and inspection
Depreciation of test equipment
Total appraisal cost
600,000
580,000
120,000
200,000
1,500,000
Internal failure costs:
Net cost of scrap
Rework labor and overhead
Downtime due to defects in quality
Disposal of defective products
Total internal failure cost
900,000
1,430,000
170,000
500,000
3,000,000
External failure costs:
Warranty repairs
Warranty replacements
Allowances
Cost of field servicing
Total external failure cost
Total quality cost
400,000
870,000
130,000
600,000
2,000,000
7,500,000
Copyright © 2012 McGraw-Hill Ryerson Limited
$
$
11-117
Year 1
Amount
Percent*
270,000
130,000
40,000
210,000
650,000
0.54%
0.26%
0.08%
0.42%
1.30%
1.20%
1.16%
0.24%
0.40%
3.00%
560,000
420,000
80,000
140,000
1,200,000
1.12%
0.84%
0.16%
0.28%
2.40%
1.80%
2.86%
0.34%
1.00%
6.00%
750,000
810,000
100,000
340,000
2,000,000
1.50%
1.62%
0.20%
0.68%
4.00%
900,000
2,300,000
630,000
1,320,000
5,150,000
9,000,000
1.80%
4.60%
1.26%
2.64%
10.30%
18.00%
0.80%
1.74%
0.26%
1.20%
4.00%
15.00% $
* As a percentage of total sales. In each year sales totaled $50,000,000.
Quality cost
reports provide
an estimate of
the financial
consequences
of the
company’s
current defect
rate.
LO 7
11-118
Quality Cost Reports in Graphic Form
$10
20
Quality Cost (in millions)
8
7
6
External
Failure
External
Failure
5
Internal
Failure
4
3
Internal
Failure
2
1
0
Appraisal
Appraisal
Quality
reports
can also
be
prepared
in
graphic
form.
18
Quality Cost as a Percentage of Sales
9
16
14
12
Prevention
1
2
Year
Copyright © 2012 McGraw-Hill Ryerson Limited
External
Failure
10
Internal
Failure
8
6
Internal
Failure
4
2
Prevention
External
Failure
0
Appraisal
Appraisal
Prevention
Prevention
1
2
Year
LO 7
11-119
Uses of Quality Cost Information
Help managers see the
financial significance of
defects.
Help managers identify
the relative importance
of the quality problems.
Help managers see
whether their quality
costs are poorly
distributed.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 7
11-120
Limitations of Quality Cost Information
Simply measuring quality
cost problems does not
solve quality problems.
Results usually lag
behind quality
improvement programs.
The most important
quality cost, lost sales, is
often omitted from
quality cost reports.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 7
11-121
ISO 9000 Standards
ISO 9000 standards have become
international measures of quality.
To become ISO 9000 certified, a
company must demonstrate:
1. A quality control system is in use, and the
system clearly defines an expected level of
quality.
2. The system is fully operational and is
backed up with detailed documentation of
quality control procedures.
3. The intended level of quality is being
achieved on a sustained basis.
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 7
11-122
Profitability Analysis
Appendix 11A
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 8
11-123
Sales Variance Analysis
Consider the following example for CardCo:
Budget
Actual
Sales in units
Deluxe cards
14,000
17,000
Standard cards
6,000
5,000
Price per unit
Deluxe cards
$18
$16
Standard cards
$ 9
$10
Market volume
Deluxe cards
75,000
85,000
Standard cards
95,000
90,000
Variable cost per unit
Deluxe cards
$ 8
$ 8
Standard cards
$ 3
$ 3
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 8
11-124
Sales Variance Analysis
CardCo Actual and Budgeted Results
Actual Results
Revenue:
Deluxe
Standard
(17,000x16) $ 272,000
(5,000x10)
50,000
322,000
Variable expenses:
Deluxe
(17,000x8)
136,000
Standard
(5,000x3)
15,000
151,000
Contribution margin
$ 171,000
Copyright © 2012 McGraw-Hill Ryerson Limited
Flexible Budget
Master Budget
Actual results are based on
the actual quantity sold
multiplied by the actual selling
price
or
variable cost
LO 8
11-125
Sales Variance Analysis
CardCo Actual and Budgeted Results
Actual Results
Flexible Budget
Master Budget
Revenue:
Deluxe
Standard
(17,000x16) $ 272,000 (17,000x18) $ 306,000
(5,000x10)
50,000
(5,000x9)
45,000
322,000
351,000
Variable expenses:
Deluxe
(17,000x8)
136,000 (17,000x8)
136,000
Standard
(5,000x3)
15,000
(5,000x3)
15,000
151,000
151,000
Contribution
marginbudget
$ 171,000
$ 200,000
Flexible
results are
based on the actual quantity
sold multiplied by the budgeted
selling price
or
variable cost
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 8
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Sales Variance Analysis
CardCo Actual and Budgeted Results
Actual Results
Revenue:
Deluxe
Standard
Flexible Budget
Master Budget
(17,000x16) $ 272,000 (17,000x18) $ 306,000 (14,000x18) $
(5,000x10)
50,000
(5,000x9)
45,000
(6,000x9)
322,000
351,000
Variable expenses:
Deluxe
(17,000x8)
136,000 (17,000x8)
136,000 (14,000x8)
Standardbudget
(5,000x3)
15,000
(5,000x3)
15,000
(6,000x3)
Master
results are
based
151,000
151,000
on
the
budgeted
quantity
sold
Contribution margin
$ 171,000
$ 200,000
$
252,000
54,000
306,000
112,000
18,000
130,000
176,000
multiplied by the budgeted
selling price
or
variable cost
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 8
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Sales Variance Analysis
CardCo Actual and Budgeted Results
Actual Results
Revenue:
Deluxe
Standard
Flexible Budget
(17,000x16) $ 272,000 (17,000x18) $
(5,000x10)
50,000
(5,000x9)
322,000
Variable expenses:
Deluxe
(17,000x8)
136,000 (17,000x8)
Standard
(5,000x3)
15,000
(5,000x3)
151,000
Contribution margin
$ 171,000
$
Master Budget
306,000 (14,000x18) $ 252,000
45,000 (6,000x9)
54,000
351,000
306,000
136,000
15,000
151,000
200,000
(14,000x8)
(6,000x3)
112,000
18,000
130,000
$ 176,000
Sales Price Variance
$29,000 U
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 8
11-128
Sales Variance Analysis
CardCo Actual and Budgeted Results
Actual Results
Revenue:
Deluxe
Standard
Flexible Budget
(17,000x16) $ 272,000 (17,000x18) $
(5,000x10)
50,000
(5,000x9)
322,000
$29,000U
Variable expenses:
Deluxe
(17,000x8)
136,000 (17,000x8)
Standard
(5,000x3)
15,000
(5,000x3)
151,000
Contribution margin
$ 171,000
$
Master Budget
306,000 (14,000x18) $ 252,000
45,000 (6,000x9)
54,000
351,000
306,000
136,000
15,000
151,000
200,000
(14,000x8)
(6,000x3)
112,000
18,000
130,000
$ 176,000
or
Sales Price Variance = (Actual – Budgeted price) × Actual sales volume
Deluxe = ($16–$18) × 17,000 units = $34,000 U
Standard = ($10–$9) × 5,000 units = $ 5,000 F
Total sales price variance
= $29,000 U
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 8
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Sales Variance Analysis
CardCo Actual and Budgeted Results
Actual Results
Revenue:
Deluxe
Standard
Flexible Budget
(17,000x16) $ 272,000 (17,000x18) $
(5,000x10)
50,000
(5,000x9)
322,000
Variable expenses:
Deluxe
(17,000x8)
136,000 (17,000x8)
Standard
(5,000x3)
15,000
(5,000x3)
151,000
Contribution margin
$ 171,000
$
Master Budget
306,000 (14,000x18) $ 252,000
45,000 (6,000x9)
54,000
351,000
306,000
136,000
15,000
151,000
200,000
(14,000x8)
(6,000x3)
112,000
18,000
130,000
$ 176,000
Sales Volume Variance
$24,000 F
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 8
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Sales Variance Analysis
CardCo Actual and Budgeted Results
Actual Results
Revenue:
Deluxe
Standard
Flexible Budget
(17,000x16) $ 272,000 (17,000x18) $
(5,000x10)
50,000
(5,000x9)
322,000
Variable expenses:
Deluxe
(17,000x8)
136,000 (17,000x8)
Standard
(5,000x3)
15,000
(5,000x3)
151,000
Contribution margin
$ 171,000
$
Master Budget
306,000 (14,000x18) $ 252,000
45,000 (6,000x9)
54,000
351,000
306,000
136,000
15,000
151,000
200,000
(14,000x8)
(6,000x3)
112,000
18,000
130,000
$ 176,000
$24,000F
or
Sales Volume Variance= (Actual – Budgeted quantity) × Budgeted CM
Deluxe = (17,000–14,000) × ($18–$8) units = $30,000 F
Standard = (5,000–6,000) × ($9–$3) = $ 6,000 U
Total sales volume variance
= $24,000 F
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 8
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Sales Variance Analysis
The Sales Volume Variance can further be broken
down into the:

=

=
Market Volume Variance
{
Actual
market
volume
–
}
Budget
market
volume
Expected
Budgeted
× market × CM per
share %
unit
Market Share Variance
[ {
Actual
sales –
quantity
Copyright © 2012 McGraw-Hill Ryerson Limited
Actual
market
share
}]
Expected
– market
share
Budgeted
× CM per
unit
LO 8
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Sales Variance Analysis
For CardCo, the Sales Volume Variance of $24,000 F
breakdown further as follows:
 Market Volume Variance
Deluxe = (85,000–75,000) × (14,000/75,000) × (18–8) = 18,667 F
Standard = (90,000–95,000) × (6,000/95,000) × (9–3) = 1,895 U
(1) 16,772 F
Total Market Volume Variance

Market Share Variance
Deluxe = [17,000–(85,000 × 14,000/75,000)] × (18–8) = 11,333 F
Standard = [5,000–(90,000 × 6,000/95,000)] × (9–3) = 4,105 U
(2) 7,228 F
Total Market Share Variance
Sales Volume Variance
Copyright © 2012 McGraw-Hill Ryerson Limited
= (1) + (2) =
24,000 F
LO 8
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Sales Variance Analysis
The Sales Volume Variance can also be broken
down into the:
 Sales Mix Variance
=

{
Actual sales
quantity
–
Actual sales
quantity at
expected sales
mix
}
× Budgeted CM
per unit
Sales Quantity Variance
=
{
Actual sales
quantity at
expected sales
mix
Copyright © 2012 McGraw-Hill Ryerson Limited
}
Anticipated
– sales
quantity
× Budgeted CM
per unit
LO 8
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Sales Variance Analysis
For CardCo, the Sales Volume Variance of $24,000F
is made up of:
 Sales Mix Variance
Deluxe = [17,000–(22,000 × 14/20)] × (18–8)
Standard = [5,000–(22,000 × 6/20)] × (9–3)
Total Sales Mix Variance

=16,000 F
= 9,600 U
(1) 6,400 F
Sales Quantity Variance
Deluxe = [(22,000 × 14/20)–14,000] × (18–8)
Standard = [(22,000 × 6/20)–6,000] × (9–3)
Total Sales Quantity Variance
Sales Volume Variance
Copyright © 2012 McGraw-Hill Ryerson Limited
=14,000 F
= 3,600 F
(2) 17,600F
= (1) + (2) = 24,000F
LO 8
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Marketing Expense
Appendix 11B
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 9
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Costs Factors to Consider in a Marketing Strategy
Transport
Warehousing
Marketing Strategy
Advertising
Selling
Credit
Copyright © 2012 McGraw-Hill Ryerson Limited
LO 9
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Order Getting and Order Filling
More Discretionary
Order Getting
Advertising
Selling Commissions
Travel
Order Filling
Warehousing
Copyright © 2012 McGraw-Hill Ryerson Limited
Transportation
Packing
Credit
LO 9
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End of Chapter 11
Copyright © 2012 McGraw-Hill Ryerson Limited