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Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15-48 Proration of Variances (60 minutes)
Proration of Direct Materials Variances
Proration of DM Proration of DM Net Change Total $DM
Standard Price Variance, PV Total after Usage Variance After After
DM Cost % Amount Prorating PV % Amount Proration Proration
DM, EI $ 65,000 13.402 $ 1,340 $ 66,340 $ 1,340 $ 66,340
1. The amount of direct materials price variance, PV, prorated to finished goods ending inventory: $1,794
2. The total amount of direct materials in finished goods ending inventory after proration of all materials variances:
$85,732
Proration of Direct Labor & Manufacturing OH Variances
Direct labor rate variance $20,000U
Direct labor efficiency variance 5,000F
Total direct labor variance $15,000U
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15-48 (Continued-1)
Total Cost DL Cost before Proration of Prorated Total
Before Proration DL OH DM Cost after
Proration Dollar % Variance Variance Variance Proration
FG 321,900 130,500 15 2,250U 900F 1,268F 321,982
3. The total amount of direct labor in finished goods inventory at December 31, after all variances have been prorated:
$130,500 + $2,250 = $132,750
4. The total cost of goods sold for the year ended December 31 after all variances have been prorated: $1,681,678
5. Generally accepted accounting principles (GAAP) (FASB ASC 330-10-30-3 to -7, previously SFAS151—“Inventory
Costs: An Amendment of ARB No. 43, Chapter 4,” and available at www.fasb.org) reaffirms (and brings U.S. reporting
standards more in line with International Accounting Standards in the area) that “abnormal” amounts of “idle facility
capacity is used for allocating fixed overhead costs to product, then any amount of unallocated overhead should be
viewed as “abnormal” and therefore treated as a period cost.
6. The point of this question is to impress upon students the fact that under absorption costing, reported operating income
can be affected by the method used to dispose of any production volume variance associated with fixed overhead. In
other words, the variance-disposition method can be used to “manage earnings” under absorption costing.
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15-48 (Continued-2)
production volume variance is disposed of at the end of the period. Specifically, this
ability to affect reported income is confined to the situation where the production
volume variance is written off entirely to cost of goods sold (CGS), as follows:
• If inventory is increasing, choosing a lower denominator-volume level will
enhance the increase in absorption costing income due to the deferral of fixed
overhead in inventory.
denominator levels if they expect inventory to increase. Note, however, that if the
production volume variance is prorated based on the units creating the variance,
then the denominator-level choice has no effect on absorption-costing income. This
is because prorating this variance effectively changes the budgeted overhead
application rate to the actual overhead application rate.
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15-49 Four-Variance Analysis and Journal Entries (60-75 Minutes)
1.
Standard Factory Overhead Rates
Variable factory OH $3,600,000 600,000 DLHs = $ 6.00 per DLH
Fixed factory OH $3,000,000 600,000 DLHs = $ 5.00 per DLH
53,500 DLHs × 26,000 units × 2 DLH/unit
$6.00/DLH = 52,000 DLHs × $6/DLH
$315,000 = $321,000 = $312,000
$260,000 $250,000 26,000 × 2 × $5 = $260,000
Spending Variance Production Volume Variance
= $10,000 U (c) = $10,000 F (d)
e. Under- or overapplied manufacturing overhead
($315,000 + $260,000) − ($312,000 + $260,000) = $3,000 underapplied
or, $6,000F − $9,000U − $10,000U + $10,000F = $3,000 underapplied
15-65
15-49 (Continued-1)
2. Summary Journal Entries (this solution assumes that the company uses an actual
and an applied account for variable overhead and an actual and an applied account
for fixed overhead costs):
Dr. Variable Factory Overhead—Actual 315,000
Cr. Utilities Payable, wages payable, etc. 315,000
To record actual variable overhead costs for the period.
Dr. WIP Inventory 312,000
Cr. Variable Factory Overhead—Applied 312,000
To apply standard variable overhead costs to production.
Dr. Variable Factory Overhead—Applied 312,000
Dr. Variable Overhead Efficiency Variance 9,000
Cr. Variable Overhead Spending Variance 6,000
Cr. Variable Factory Overhead—Actual $315,000
To record variable overhead variances for the period.
Dr. Fixed Factory Overhead—Actual 260,000
Cr. Salaries payable, accumulated depreciation, etc. 260,000
To record actual fixed overhead costs for the period.
Dr. WIP Inventory 260,000
Cr. Fixed Factory Overhead—Applied 260,000
To apply standard fixed overhead costs to production.
Dr. Fixed Factory Overhead—Applied 260,000
Dr. Fixed Factory Overhead Spending Variance 10,000
Cr. Production Volume Variance 10,000
Cr. Fixed Factory Overhead—Actual 260,000
To record fixed overhead variances for the period.
3. Closing Journal Entry:
Dr. Variable Overhead Spending Variance 6,000
Dr. Production Volume Variance 10,000
Dr. Cost of Goods Sold (CGS) 3,000
Cr. Variable Overhead Efficiency Variance 9,000
Cr. Fixed Overhead Spending Variance 10,000
4. Generally accepted accounting principles (GAAP) (viz., FASB ASC 330-10-30-3 to -7,
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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line with International Accounting Standards in the area) that abnormal amounts of
15-49 (Continued-2)
idle facility expense (as well as abnormal amounts of freight, handling costs, and
spoilage) be written off as a period expense (i.e., as a current-period charge).
5. The point of this question is to impress upon students the fact that under absorption
costing, reported operating income can be affected by the method used to dispose
of any production volume variance associated with fixed overhead. In other words,
the variance-disposition method can be used to “manage earnings” under absorption
costing.
inventory can be intensified or reduced based on how the production volume
variance is disposed of at the end of the period. Specifically, this ability to affect
reported income is confined to the situation where the production volume variance is
written off entirely to cost of goods sold (CGS), as follows:
• If inventory is increasing, choosing a lower denominator-volume level will
Thus, it is through the interaction of how the fixed overhead rate is set and how the
resulting production volume variance is accounted for that provides management an
opportunity to manage earnings under absorption costing. The above points suggest
that managers can increase short-run operating income by: (1) choosing larger
denominator levels if they expect inventory to decrease, or (2) choosing smaller
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15-50 Research Assignment: Control of Overhead Costs; Strategy (45-60 Minutes)
74-82.
1. In general, how does this article relate to the material covered in Chapter 15?
Chapter 15 deals with the accounting for and the management of indirect costs—
principally, indirect manufacturing costs (i.e., manufacturing overhead). The
discussion in Chapter 15 extends the discussion from Chapter 14 and as such uses
standard costs and flexible budgets at the end of an accounting period to generate
various standard cost variances. The framework presented in Chapters 14 and 15 is
a traditional model for achieving short-term financial control.
The article in question extends the discussion in Chapter 15 by focusing on the
control of administrative costs (what are referred to in the title of the article as
“overhead” costs). As such, the discussion should be of interest to a wider audience.
The beginning of the article notes an important context: you, as the decision
2. The authors state (p. 75) that “administrative cost-reduction opportunities follow
similar patterns virtually everywhere.” What two major conclusions do the authors
offer, based on the accumulated experience in implementing successful cost-cutting
programs?
One, organizations typically are not able to meet their cost-cutting goals with a single
idea or plan. In fact, as a rule-of-thumb, the authors suggest that typically a
On the other hand, a combinations of less-disruptive (i.e., more locally confined)
action plans would be entirely appropriate for a lower cost-reduction goal (e.g.,
10%).
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15-50 (Continued-1)
3. The authors of this article also state (p. 75) that cost-reduction goals typically require
10% Cost-Reduction Goal (“Incremental Ideas”)
1. Consolidate incidentals (e.g., combining training days or celebrations into a single
event; cross-scheduling the use of external resources, such as facilities or
trainers)
2. Take overdue personnel actions (e.g., job restructuring, underperformers)
3. Reduce spending on department managers (e.g., can the organization get by with
cycles for such investment opportunities that may now be viable)
20% Cost-Reduction Goal (“Redesign Ideas”)—can the demands on your
department be reduced so that resource savings can accrue?
1. Talk to your counterparties (to reveal cost-saving opportunities in terms of
4. Can resource spending tied to preventing against low-probability, low-
consequence events be reduced? (For example, is it necessary to check 100% of
data 100% of the time?)
30% Cost-Reduction Goal (Cross-Department and Program-Elimination Ideas;
1. Coordinate parallel activities (e.g., purchasing of supplies, travel
planning/discounts)
2. Shift the burden to the most efficient location (e.g., are there outsourcing
possibilities?)
cross-departmental initiatives, transfers, programs, etc.)
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15-50 (Continued-2)
4. Eliminate low-value meetings and forums (to free employees to do more
creative/productive tasks)
5. Eliminate certain tasks performed by or programs conducted by your department
6. Reduce the burden your department places on others (e.g., how are other
departments overserving your department?
4. Provide a concise summary of the authors’ recommended approach for determining
the “right level of overhead.”
The authors’ thoughts in this regard are presented at the top of pages 78 and 79.
From management’s perspective, the underlying issue is “are we cutting enough—or
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15-51 ABC Data, Capacity-Resource Planning, Non-Financial Performance Indicators
(40-45Minutes)
1.
2.
Actual Cost Budgeted Unused
Activity Rate Activity Units Assigned Cost
Capacity (units)
Handling Customer Orders $80 8,000 $640,000 $800,000 2,000
Processing Complaints $200 400 $80,000 $100,000 100
Conducting Credit Checks $200 500 $100,000 $100,000 0
Unused Cost of Unused
Activity Capacity % Capacity
Handling Customer Orders 20.00% $160,000
Processing Complaints 20.00% $20,000
Conducting Credit Checks 0.00% $0
$180,000
3. For each activity, we calculate in (2) an estimated cost of "unused capacity." The
4. Customer Service activities can be viewed as part of the larger "Customer
Management" process. Conceptually, the company should establish one or more
Estimated
(Budgeted)
Allocated
Cost-Driver
Activity Cost-
Activity
%
Cost
Quantity
Driver Rate
Handling Customer Orders
80%
$800,000
8,000
$100
per customer order
Processing Complaints
10%
$100,000
400
$250
per customer complaint
Conducting Credit Checks
10%
$100,000
500
$200
per credit check conducted
100%
$1,000,000
Actual Cost-
Activity-Cost
Allocated
Activity
Driver Quantities
Driver Rates
Cost
Handling Customer Orders
8,000
$100
$800,000
Processing Complaints
400
$250
$100,000
Conducting Credit Checks
500
$200
$100,000
Total Allocated Cost =
$1,000,000
Under this method, the cost of unused capacity cannot be determined. Note that all of the $1,000,000 support
cost will be allocated to the outputs (products or services) produced during the period.
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15-51 (Continued)
Respond Quickly to Customer Feedback and Complaints:
a) Average time needed to resolve customer complaint
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15-52 Managing Resource Capacity through Activity-Based Costing (ABC) (60
Minutes)
1. “Variable” and “fixed” costs represent descriptions of how a given cost changes in
response to one or more specified activities or “cost drivers.” (Mathematically, we
would say that “cost” is the dependent variable and the cost drivers represent
independent variables. A mathematical equation, in linear or non-linear form, can be
used to depict the underlying “behavior” of a given cost.)
We say a given cost is “variable” if, in the short run, that cost changes in response to
one or more cost drivers. In other words, such costs change, in total, as related
of how much of the resource is used in a given period. Examples include things such
as engineering salaries, production scheduling, sales and marketing managers, and
depreciation expense (or most rental expenses).
For many organizations today, their support costs are significant in amount and
largely short-term fixed. That is, many (if not most) support costs, including
manufacturing overhead, are incurred regardless of short-term demands. This, in
turn, presents an important managerial challenge: how to manage the demand for
2. In implementing an ABC system, management has several options at its disposal in
terms of how the ABC cost-allocation rates are determined. For example, the
denominator in each calculation can be either actual or budgeted activity. The former
Chapter 15 - Operational Performance Measurement: Indirect-Cost Variances and Resource-Capacity Management
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15-52 (Continued-1)
prices, and order acceptance, the company may set an increased price to offset the
seemingly increased activity cost rates. Predictably, the effect is even lower demand,
lower activity volume, and higher activity cost rates. This situation is referred to in the
literature as the death-spiral effect. Eventually, there are no customers left to bear
the (basically fixed) support costs!
we might define “practical capacity” as the amount of work (or activity) that can be
performed without creating unusual delays, forcing overtime work, or requiring
additional resources to be supplied. Operationally, we might define “practical
capacity” as a percent (e.g., 85%) of maximum/theoretical capacity.
3. Determination of Activity-Cost Rate for "Handling Customer Orders" Activity
Budgeted Resource Spending (i.e., the numerator) = $560,000
No. of Orders @ Practical Capacity (i.e., the denominator) = 10,000
Support Cost Rate: Per Order Handled = $56.00
The management of support costs for companies like Zen is of strategic concern
because, more than likely, the company is competing on the basis of a differentiation
strategy. Thus, managing resource spending in support areas (e.g., manufacturing
support, customer support) is strategically important. Further, the dollar amount of
such costs are likely to be large and therefore worthy of special attention (monitoring
and control).
4. The point of this question is to demonstrate that the ABC data, based on practical
capacity, can be used to reveal the increased efficiencies associated with the TQM
