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Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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traditional standard cost system (including the allocation of service department costs to production
departments). The cost model used in the pilot implementation is depicted in Figure 1 of the article.
related costs to products.
As indicated in Table 2, these design choices had a significant effect on indicated product costs.
4. What do the authors propose as the primary advantages of the RCA system piloted at the
Augusta, KY plant of the Clopay Plastics Company?
A comparison of RCA to traditional cost systems is provided in the upper portion of Table 1 in the
article. Specific benefits that Clopay realized with its RCA implementation are summarized in the lower
portion of Table 1.
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15-7: “Better Information through the Marriage of ABC and Traditional Standard Costing
Techniques” by William W. Stammerjohan, Management Accounting Quarterly (Fall 2001), pp.
15-21.
This article recommends extending traditional standard cost variance analysis for overhead to an ABC
setting. As such, it attempts to provide a bridge between a traditional financial-control model (the use of
standard costs, flexible budgets, and standard cost variance analysis) to a more contemporary setting: the
use of activity-based cost (ABC) systems.
Discussion Questions:
1. Provide an overview of traditional standard cost variance analysis for manufacturing (factory)
overhead costs.
As noted in the article (and in Chapter 15 of the text—see Exhibits 15.6 and 15.7), the total factory
overhead variance for a period (also referred to as the total over or under applied overhead for the
period) is defined as the difference between the actual overhead costs incurred and the standard
overhead costs charged to production. This total variance can be decomposed using a two-way, a three-
variance. (See Table 2 of the article for a summary of traditional overhead variances calculated using
the data provide in the article.)
2. According to the author, what are the primary limitations of traditional standard overhead
variance analysis?
a) Inability to model/track multiple cost drivers associated with the incurrence of manufacturing
overhead costs, and their subsequent assignment to products/services produced.
b) Failure to properly model underlying cost functions, e.g., the use of unit-level (or volume-based) cost
drivers to assign overhead costs to outputs. Examples of unit-level cost drivers would be units
analysis treats as capacity-related (i.e., short-term fixed) costs. (See the textbook, Chapter 15, for an
extended discussion of this issue.)
3. What is the essence of the author’s recommended approach for amending traditional variance
analysis?
Essentially, the author proposes a refinement to traditional standard cost variance analysis for overhead.
Of particular importance is the separate treatment of unit-level from batch-level overhead costs and
their related variances for a period. (See Tables 4 and 5 for a summary of the overhead cost variances
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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causes of overhead efficiency variances.
4. What recordkeeping (i.e., information-processing) costs are associated with the revised system
recommended by the author?
To take full advantage of the more detailed techniques recommended in this article, it will be necessary
for companies to continually update the standard quantities and the standard prices of resource inputs.
The standard production hours, standard setup hours, and standard prices for labor, indirect materials,
information on the number of parts produced, the number of hours worked, the operator cost, the
indirect materials cost, and the utility cost, these techniques require additional information. While
tracking additional information—such as monitoring utility consumption for each machine—may
require improvements to existing information systems, we may find, in many cases, that this type of
information is already being captured by contemporary, sophisticated information systems.
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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Reading 15-8: “No Equivocating—Expense Those Idle Capacity Costs” by Sid R. Ewer,
Craig Keller, and Stevan K. Olson, Strategic Finance (June 2010), pp. 55-59.
A few tiny words can sometimes have a big impact, especially when it comes to accounting standards.
And it isn’t just when words are added—it can also be a big deal when they disappear. Some seemingly
minor changes to SFAS No. 151may end equivocation when it comes to expensing the cost of idle
capacity.
Discussion Questions:
1. According to the article, what was the overall purpose of SFAS #151 (“Inventory Costs—An
Amendment of ARB No. 43, Chapter 4”)?
The FASB, as a part of its ongoing cooperative efforts with the IASB to harmonize accounting
151 can be found in the Codification in Section 330-10-30, paragraphs 1-8.
2. What are the principal accounting changes associated with SFAS (i.e., in what respect does SFAS
#151 amend ARB No. 43, Chapter 4)?
For fiscal years beginning after June 15, 2005, companies are subject to the changes brought about by
SFAS No. 151. These changes relate to accounting for inventories, and are summarized by the authors
in Table 1 of the article. Basically, SFAS requires that in determining the fixed overhead application
fixed manufacturing cost is to be based on this higher level of output (so as to prevent inventories from
being valued at an amount greater than “actual cost”). Finally, we note that SFAS No. 151 defines
“normal capacity” not as a point value but rather as a range of output.
3. What examples of “abnormally low” production/output are provided in SFAS No. 151?
4. According to the authors of this article, what are fours ways of “ameliorating” the effects of
SFAS No. 151 (in terms of the need to charge as current-period expense the ongoing costs related to
abnormally low production or idle plant)?
1. Finding alternate uses, production, or service for otherwise idle plants, property, and equipment.
2. If entire plants are shut down and put up for sale, the property is no longer “in productive use” and
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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as such should be reclassified from fixed assets (“property and equipment”) to some type of
investment category. This would then remove the associated depreciation cost out of the overhead
rate calculation.
3. Asset write-down: if the company determines that an “asset impairment” has occurred, it could
write-down the cost of the asset (and reporting the associated write-down as a loss). This would, in
4. The authors indicate that in some circumstance, LCM (lower-of-cost or market) rules for inventory
valuation may render the issue moot. If, because of abnormally low production volume, a company
were to include idle capacity costs as part of inventory, the costs, if excessive, may cause recorded
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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Reading 15-9: “Idle Capacity Costs: It Isn’t Just the Expense,” by B. Bettinghaus, M.
Debruine, and P. R. Sopariwala, Management Accounting Quarterly (Winter 2012), pp. 1-7.
SFAS No. 151 calls for manufacturing firms to report the abnormal level of unused fixed production
costs as a period cost and not include these costs in inventory. The authors of this article find that
normal idle capacity costs are quite large and relevant to investors. They also argue that these unused
fixed costs are made up of past, current, and future cash outlays, the composition of which should
vary widely across firms. Based on these observations, the authors argue that the current reporting
standard does not go far enough. They propose a standard that requires firms to recognize the expense
on the income statement and the idle assets on the balance sheet and to include disclosures detailing
the breakdown of the expense between cash flows and accruals.
Reading 15-9 can be thought of as a follow-up to Reading 15-8 by Ewer et al. (2010).
Discussion Questions
1. How would you summarize the main arguments made by the authors of this article?
As indicated in Reading 15-8, SFAS #151 requires companies to expense as period costs the cost of
“abnormal idle capacity.” The authors of Reading 15-9 assert that what can be considered “normal”
amounts of unused capacity costs (i.e., idle capacity costs associated with unabsorbed fixed
that since “normal” idle capacity costs are made up of a combination of past, present, and future cash
outlays that companies be required to disclose on the financial statements the breakdown of these costs
into cash and accrual amounts each year. In short, the authors argue for a change in financial reporting
standards covering “normal” amounts of idle capacity costs. Put another way, the authors argue that
“The current standard that calls for the reporting of abnormal idle capacity seems to result in no
disclosure, even when idle capacity is quite large.”
2. What evidence is offered by the authors that the disclosure of idle capacity costs is investor-
relevant?
The authors suggest that knowledge of “normal” amounts of idle capacity costs is relevant for
predicting future operating profits. To support their argument, the authors studied four automobile
information, the authors argue that “The estimates of idle capacity (for GM North America) range
from $2.5 billion in 2006, when GMNA had made drastic cuts in fixed costs, to $7.3 billion in 2008,
when GMNA sales fell by more than 25% from the year before (see Table 2).” Over this same period,
the authors suggest that “GMNA’s total operating income, i.e., sales revenue less the cost of resources used to
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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earn the sales revenue, was about $4.4 billion, whereas its cost of idle capacity over the same period was about
$32 billion.” Bottom line: one could argue that these amounts are clearly material to the interpretation of
financial performance of GMNA. In response, the authors muse: Might General Motors Corporation have taken,
or been forced to take, the appropriate corrective actions to reduce its idle capacity and avoid bankruptcy if
financial reporting had required disclosure of the cost of idle capacity?
3. In general terms, increased disclosures recommended by the authors are outlined above in
response to question #1. What are the specifics of the authors’ recommendations?
The authors begin with the observation that capacity costs for the auto companies examined consist of
three components: allocations of prior-period cash outlays (e.g., depreciation on plant and equipment),
current period cash outlays (e.g., salaries), and future cash outlays (e.g., post-retirement expenses
accrued in the current period). Thus, the authors argue that in addition to the total amount of capacity
(and by extension, idle capacity) costs being relevant, the mix or composition or breakdown of these
capacity. Moreover, if the domestic automakers have more excess capacity than the foreign
automakers, then their cash outlays associated with the excess capacity still would be higher.” In the
case of GMNA, over the period studied, “only 17% of the estimated $32 billion (of capacity cost) was
depreciation, which leaves $26.5 billion that GMNA lost in cash over this period.”
Thus, based on the above analysis and associated assumptions, the authors call for the following
expanded disclosures regarding capacity-related costs:
1. Disclose the cost of “normal” idle capacity costs separately on the Income Statement (rather than
“burying” such costs as part of cost of goods sold)
In terms of items 1 and 3 above, the authors allude to Statement of Financial Accounting Concepts No.
5, “Recognition and Measurement in Financial Statements of Business Enterprises,” which states that
to be recognized in the financial statements, an item should meet the following four criteria: the item
under consideration should meet the definition of an element; it should be measurable; it should be
relevant to financial statement users; and, it should reliably represent the economics of the
transaction.” The authors argue that their recommended financial statement items (1 and 3 above) in
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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Reading 15-10: “A Guide to Integrating Revenue Management and Capacity Analysis,” by
Ronald J. Huefner, Management Accounting Quarterly (Fall 2011), pp. 40-46.
Companies of all sizes are limited by any number of constraints: capacity of their plants and other
physical structures, distribution channels, rules and regulations, size and education of the workforce, and
access to raw materials, to name a few. Yet it is often not the resources you have—but what your
organization does with them—that can make the difference between barely profitable and booming. This
article provides suggestions as how to make the most of your opportunities in this regard.
Discussion Questions
1. What is meant by the term “revenue management” and how does this topic relate to the topics
covered in Chapter 15 of the text?
As defined by the author, “revenue management” means “generating additional revenue by selling used
capacity profitability.” (emphasis added) Chapter 15 has, as one of its major themes, coverage of the topic
of resource-capacity management. Typically, this topic is discussed from the standpoint of driving down
model developed by Computer-Aided Manufacturing—International (CAM-I).
2. What “contextual factors” does the author suggest as related to the importance and use of
“revenue management” techniques? That is, what are the primary characteristics of organizations
that have adopted revenue-management techniques?
The following characteristics are associated with the adoption of revenue-management techniques:
1. Capacity is fixed (at least in the short run): examples include airlines, hotels, golf courses.
2. Service capacity is perishable (services cannot be “inventoried” for sale at a later date; that is,
unused service capacity “expires”)
shift their consumption/demand pattern if the price incentive is sufficiently attractive)
5. Ability to forecast demand (alternatively, this involves estimating the price-elasticity of demand for
different market segments)
3. According to the author, how can the CAM-I model be applied to the task of “revenue
management”?
The author identifies four components of “capacity”: physical capacity, personnel capacity, process
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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capacity, or productive capacity.
Table 1 of the article presents a breakdown of rated capacity (total time) for a hypothetical restaurant
author: “Knowing how much of a business’s physical capacity is idle or nonproductive—and why—
can point to opportunities for revenue growth.”
4. List some specific action plans that could be taken by Sara to improve profitable revenue growth.
• Pricing promotions (such as coupons or early-bird specials), could increase the number of customers,
• Offering take-out or catering options
5. Finally, provide a brief overview of the other dimensions of “capacity” (i.e., beyond what is
meant by “physical capacity”)
Personnel Capacity: Within the context of Sara’s Table, Table 2 of the article discloses that the total
personnel capacity is 140 hours per day, and that because the restaurant is not staffed at times other
than 4pm to 11 pm on the six days the restaurant is open, there is no idle capacity for personnel.
Purchases Capacity: This refers to the available supply chain for materials, supply, and externally
Two important points seem to stand out in terms of this article:
1. The topic of “revenue management” (or, previously, “yield management”) has not seen adequate
attention in the management accounting literature. Rather, cost management (or cost control or
