answer key kinneyaise15im

331 This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. This may not be

resold, copied, or distributed without the prior consent of the publisher.

Chapter 15 Managing Costs and Uncertainty

Questions 1. The cost control system is an integral part of

the cost management system. The cost control system provides information for planning purposes and, subsequently, for evaluation of actual performance.

2. Without first establishing performance targets

and benchmarks, control systems cannot function. The purpose of establishing control systems is to guide the organization toward its established objectives. Accordingly, the control cycle must begin with the establishment of plans that define where the organization is headed and what its managers want to accomplish.

3. Cost control for any specific event is exerted

before, during, and after the event. Cost control is exerted before the event to determine the expected cost and to provide a plan to achieve the expected cost. During an event, control is exerted to maintain the cost being incurred at the planned level. After an event, actual performance is compared to planned performance and explanations of differences are developed. By understanding why differences exist, managers can take actions to minimize future differences between the actual and planned amounts.

4. Factors potentially causing a cost to change

include: (1) changes in activity level; (2) change in inflation/deflation; (3) technology changes; (4) changes in supply and demand; (5) quantity of competition;

(6) seasonality and other timing phenomena; and

(7) quantity purchased.

Factors 1 and 5-7 are most subject to cost containment. The difference in controllability is the extent to which the factor can be influenced by actions of managers. The factors that are external to the firm are less subject to control than (e.g., inflation) internal

factors (e.g., activity levels). 5. Total fixed costs can be dichotomized into two

groups, committed and discretionary. The committed fixed costs are ones that are less susceptible to cost control efforts, at least during the short run. These costs consist of costs associated with basic plant assets and organizational infrastructure. Discretionary fixed costs are more susceptible to short-run cost control efforts. Discretionary fixed costs are incurred as a result of managerial judgment. Examples of such costs are research and development and advertising.

Costs considered as committed by one firm may be considered discretionary by other firms. For example, a firm that competes on the basis of products containing the latest functionality and technology would consider research and development to be committed. A firm that competes on the basis of price might consider research and development to be discretionary.

6. Many types of discretionary costs do not have

outputs for which there is a precisely explainable and predictable technical relationship with inputs. When an output measure is devised, it is normally available only in nonmonetary, surrogate terms. For some discretionary costs such as research and development, output may result, if at all, only after making inputs for a period of indefinite duration. Thus, even when outputs occur, it is difficult to relate them to a particular period's input.

7. Efficiency is a measure of the degree to which

the actual yield ratio (actual output ÷ actual input) conforms to the desired yield ratio (planned output ÷ planned input). Effectiveness is a measure of the degree to which a goal or objective is achieved.

Measuring the efficiency of a discretionary cost requires both a measure of input and a measure of output. Efficiency further requires a predictable cause-and-effect relationship

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10. Technology has allowed automation of many

of the processes associated with purchasing. Because of the automation, the cost of purchasing transactions has been dramatically reduced. One of the positive effects of the cost reduction has been an increase in the competitiveness of the supplier markets.

This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. This may not be resold, copied, or distributed without the prior consent of the publisher.

between input and output. Input costs are readily measured. However, as explained in the answer to Question 15, outputs are not normally readily available. When they are readily available or when surrogates can be identified, there is still often a lack of confidence about the strength of the cause-and-effect relationship between input and output for most discretionary costs.

To measure effectiveness of a discretionary activity, an output measure, either monetary or nonmonetary, must be available or devised. Sometimes a surrogate measure for output of an activity can be agreed on. Effectiveness of a discretionary cost can then be measured by comparing actual output to planned output (i.e., actual output ÷ planned output).

8. Quality control inspection cost is sometimes

susceptible to treatment as an engineered cost. Other examples of activities that could be engineered include maintenance tasks, machine setups, and employee training activities.

9. Firms hold cash balances to liquidate planned

transactions as they occur, to cover cash consequences of unexpected events, and for speculative purposes.

Some firms must carry relatively larger cash balances than other firms because either the cash required to maintain the liquidity of the operating cycle is less predictable, or the ability to obtain cash from financing sources is more constrained.

11. The first approach to dealing with uncertainty

is to explicitly consider the effects of uncertainty in estimating future costs. Uncertainty can be reduced by selecting the best predictor variables to include in forecasting models. Second the costs can be structured to automatically adjust to uncertain outcomes. For example, total variable costs automatically adjust to the realized level of sales or production. A third method of dealing with uncertainty is to use options and forward contracts. These tools are best used to deal with price uncertainty for both inputs and outputs. The final tool for dealing with uncertainty is insurance. Insurance is especially useful as a device for dealing with unexpected events such as “acts of God.”

12. Uncertainty has two main sources. First

uncertainty is related to one’s inability to perfectly foresee the future and to understand perfectly cost causality. The second source of uncertainty is the possibility of unforeseen events. For example, the tsunami occurring in late 2004 was not expected; therefore the cost of its remediation was likely not included in income and cash flow budgets and forecasts.

Exercises

13. a. Cost reduction-because quantity of work fluctuates, part-time employees

provide services for peak caseload times without full-time cost. b. Annual salary full-time clerical staff ($57,000 x 1.20) = $68,400; if 1,600 hours or less, part-time salary = $40X; if over 1,600 hours, part-time salary = $40X + $4,000 For 1,600 or fewer hours, point of indifference: $40 X = $68,400 X = $68,400 ÷ 40 X = 1,710 hours For more than 1,600 hours: $40X + $4,000 = $68,400 $40X = $64,400

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X = 1,610 hours

Thus, the point of indifference occurs at 1,610 hours. 14. a. Cost understanding b. Cost reduction c. Cost avoidance for the cost of call-forwarding; the increase in costs for

staff shows a recognition of client need and services to be provided d. Cost avoidance e. Cost reduction f. Cost avoidance of what would have been an increase in costs with the

installation of the new telephones; also shows cost understanding since she knew why the cost would increase

15. a. Classification Cost C Annual audit fees C Annual report preparation and printing C Building flood insurance D Charitable contributions D Corporate advertising D Employee continuing education C Equipment depreciation C Interest on bonds payable D Internal audit salaries D Marketing research D Preventive maintenance C Property taxes D Quality control inspection D Research and development salaries D Research and development supplies (the amount is discretionary only if R&D is to be conducted internally) D Secretarial pool salaries b. Building flood insurance, charitable contributions, corporate advertising,

employee continuing education, internal audit salaries, marketing research, preventive maintenance, quality control inspection, research and development salaries, research and development supplies, secretarial pool salaries.

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c.


Cost Surrogate Output Measure Objections Charitable Improvement in social Very difficult to contrib. welfare measure Advertising Increase in sales Uncertainty about cause & effect Employee Increase in productivity, Difficult to capture education quality all costs and benefits Internal # of internal controls No single measure audit improved will capture all benefits of internal auditing Market # of new products identified Doesn’t capture research the value of the product ideas Prev. maint. Reduction in number of Age of machines breakdowns plays a bigger role

in # of breakdowns than maintenance does Q. control Reduction in # of Other factors such as defective items returned careless handling by by customers those moving products may cause defects R & D Number of discoveries, These outputs are salaries inventions, improvements, so heterogeneous as etc. to not be additive R & D Expenditures per dollar of Doesn’t capture supplies R&D salary benefits of expenditure Secr. pool Number of documents Does not necessarily prepared measure quality of work 16. a. C Committed costs are often associated with capital investment. b. D Amounts can be set by managerial judgment.

c. C Committed costs often can not be reduced in the short run by managers. d. D Hence, the term “discretionary”

e. C These are examples of costs that are associated with capital investment. f. D Because the cause/effect association is often not well understood for

discretionary costs.

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g. D Only discretionary costs can be reduced in the short run without

impairing a firm’s long-term viability.


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h. C Committed costs are associated with capacity and capital investment. i. D Because the yield on discretionary costs is not precisely known.

j. D Discretionary activities tend to be service activities rather than costs associated with the basic infrastructure

17. a. Extent to which ABC has been implemented in the firm; dollars of cost

savings generated by ABC prescriptions b. Number of patient hours of treatment on the machine c. Change in employee retention rate, absenteeism rate d. Improvement in employee satisfaction, measures capturing improvement in

flow of people e. Customers generated from Yellow Page advertising f. Labor time savings, reduction in collection cycle, 18. a. Goal 300 new students Actual achievement 330 new students Goal exceeded by 30 new students Consequently, the department was very effective in meeting its goal. b. Yield goal: ($400,000 ÷ 300) = 1 student for each $1,333 expended.

Actual efficiency ($468,600 ÷ 330) = 1 student for each $1,420 expended. Accordingly, the department was very operationally inefficient in pursuing its objectives.

19. Total variance = $2,280 – [(105 x 1 x $16) + (12 x 1 x $24)] = $312 U Rate variance = $2,280 - [(120 x $16) + (15 x $24)] = $0 Efficiency variance = $2,280 - $1,968 = $312 U 20. a. Rate variance = $20,928 - (1,030 x $18) = $2,388 U Efficiency variance =$18,540-((12,560 ÷ 12) x $18) = $300 F Total variance = $2,388 U + $300 F = $2,088 U b. 170 hours x 12 inspections per hour = 2,040 inspections per worker Cost for full-time workers = $5,000 x 4 = $20,000 Part-time work ((1,030 - (170 x 4)) x $18 = 6,300 Total cost of this arrangement $26,300 Total expected cost of existing arrangement: 1,030 x $18 = 18,540 Disadvantage of full-time arrangement $ 7,760

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21. Actual Actual Vol. at Std. Price Budget 1,800 x $45 1,800 x $40 1,875 x $40 $81,000 $72,000 $75,000 $9,000 F $3,000 U Price Variance Volume Variance $6,000 F

Total Revenue Variance

Even though the volume of sales was 75 cords below expectation (creating an unfavorable $3,000 volume variance), the average price of the 1,800 cords actually sold was $5 above the standard or expected price. This created a $9,000 favorable price variance. The combination of the $3,000 unfavorable volume variance and the $9,000 favorable price variance results in a $6,000 favorable total variance, and not a $4,200 total variance as stated by the company president.

22. a. Expected selling price ($60 x 0.90) $ 54 Expected quantity (400 x 115%) x 460 Expected revenue $24,840 b. AV x AP AV x SP Budgeted Volume x SP 470 x $52 470 x $54 $24,440 $25,380 $24,840 $940 U $540 F Price Variance Volume Variance $400 U Total Revenue Variance 23. Variable cost analysis: Variance = actual cost - flexible budget = $450,000 - ($400 x 1,050) = $30,000 U Fixed cost analysis: Actual Budgeted Fixed Cost Applied 1,000 x $200 1,050 x $200 $220,000 $200,000 $210,000 $20,000 U $10,000 F Spending Variance Volume Variance $10,000 U Total Fixed Cost Variance

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This method of evaluation would encourage the personnel workers to hire

lower quality workers. Low-quality workers would generate more turnover than high-quality workers, thus the volume of business rises; and hiring low-quality workers requires the Personnel office to incur lower search costs than would be incurred to hire only high-quality workers.

24. No solution provided. 25. a. In his humorous communication, Mr. Stanley Bing’s strategy is to raise the

level of awareness and cost consciousness of employees regarding cost understanding and cost avoidance in the travel and entertainment category. His remarks display his keen insight and experience concerning how some employees may take liberties with company funds.

b. Mr. Bing was subtly advising employees that the prudence and

reasonableness of their use of company funds in the travel and entertainment category was about to be monitored and scrutinized much more carefully than in the past. The use (or abuse) of these funds had apparently become more significant recently and greater attention to their management and control had become necessary. The clever, lighthearted approach reflects Mr. Bing’s desire to enlist cooperation without offending.

26. a. The proposed maintenance work order system would provide written

documentation for all man hours and materials used in the maintenance department. This system would improve cost control by giving operating management (user departments) the opportunity to review specific maintenance charges for time and materials on each maintenance job charged to their department. The individual job cost records will provide the basis for feedback to the maintenance department on the quality and efficiency of work performed. By providing an estimate for each job prior to starting the job, the user department will have an opportunity to cancel unneeded work or work that appears to be too expensive. The maintenance department will be able to compare the estimates with estimates on similar jobs and with the actual costs once the job is completed in order to evaluate personnel performance. In addition, the estimating should improve scheduling of priority jobs and improve cost control as the estimating procedure is refined. The maintenance work order system will provide a basis for improved allocation of costs to user departments. If the work order system is effective and a buyer/seller relationship is developed between the user department and the maintenance department, the user department will insist on an efficient preventive maintenance program in order to minimize breakdown maintenance, spoilage, and lost production time.

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b. The documentation provided by the work order system should provide

maintenance department management with statistics to support its request for additional people. If the maintenance department can develop a meaningful cost/benefit relationship showing a payback on additional personnel through reduced overtime, less downtime waiting for repairs, improved preventive maintenance, etc., rational management would authorize the addition of the required manpower.


(CMA adapted)

27. The firm may have too much cash invested in working capital. The two accounts consuming the most cash are accounts receivable and work in process inventory. Accounts receivable can be reduced by finding ways to speed up collections. For example, arrangements can be made to electronically collect accounts from customers. Terms of sale can be tightened and stricter policies for granting credit can be imposed. For work in process inventory, ways can be found to reduce the inventory level. For instance, by speeding up production processes, less time will be consumed from the start to completion of production. Methods such as just-in-time inventory management would be useful.

Also, the company’s payables are very small relative to current assets. Current payables can be used as free financing for current assets. To illustrate, the company could negotiate for credit terms from its suppliers. This credit would be a source of financing for inventory and accounts receivable and would free up cash the company currently has invested in these accounts.

28. Among the benefits you would discuss would be the following: 1. Reduced search costs. Significant resources can be expended just to

identify the potential set of suppliers. The e-procurement system will reduce these costs.

2. Because the e-procurement system reduces the cost of transacting for potential vendors, the quantity of competition should be increased. The result should be lower prices for inputs.

3. The costs of settling up with suppliers should also be reduced because payment to the supplier can be remitted electronically. Typically electronic payments create lower transaction costs than issuing paper checks.

4. Other costs of the purchasing transactions can be reduced. For example the costs of issuing paper purchase orders can be eliminated by an e-procurement system.

29. The coefficient of determination is the percentage of variability in the dependent (predicted) variable explained by the variability of the independent (predictor) variable. Because total labor hours has the highest coefficient of determination it would be the best, single predictor variable. However a superior prediction model might be obtained by including two or even all three of the candidate variables in the model.

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30. Because the cost of metal comprises such a high percentage of total

production cost, any deviation from budget for this input could cause income to vary significantly from expectations. Accordingly, strategies should be considered for both uncertainty regarding quantity and price.


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The quantity uncertainty can be addressed by understanding how product demand affects metal usage. Thus, the quantity element may be dealt with most effectively by getting the best possible elements for product sales and by carefully monitoring the efficiency with which metal is consumed in production.

The price uncertainty can be dealt with by either forward contracting for the metal and setting the price in the contracts or by hedging the price of the metal by purchasing futures contracts.

31. First, the company should attempt to understand the drivers of the cyclicality

in the industry. To the extent the company can identify the causes of the cycle, managers can monitor the variables related to the cycle drivers and take actions that anticipate changes in the cycle. However, managers can also structure the company to be better suited to surviving the cycles. Particularly, managers should structure costs of the company to automatically adjust to changes in product demand. They can do this, for example, by organizing the cost structure of the firm to be comprised largely of variable costs.

Problems

32. a. CU b. CU c. CA d. CU e. CU f. CA or CR g. CA h. CR i. CU j. CA k. CC l. CA

33. a. Some considerations for the bookstore include:

• Exercise prudent cost management over discretionary costs. One of the more significant discretionary costs is advertising.

• Maximize use of technology. Although book handling is inherently a labor-intensive exercise, transaction processing related to sales, purchases, and repurchases can be highly automated to save labor costs.

• Institute programs to reduce employee turnover. Because many

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employees may be students, employee turnover can be very high. Employee turnover increases specific costs such as employee training, quality failure costs, and unemployment taxes.


• Arrange floor space to minimize book handling costs and to facilitate the flow of students.

• Work closely with professors to ascertain which books will be used in the upcoming semester and which will not be used again.

• Develop associations with book wholesalers to market books that are no longer adopted by the local university.

• Encourage professors to adopt the same book for multiple sections of the same class to realize economies of scale in purchasing and shipping.

• Provide incentives to students to purchase books early so that the work-load can be spread across more time and be handled by fewer employees.

• Use temporary rather than permanent employees to handle busy season work.

• Find innovative ways to manage freight costs. Examine alternative modes of transportation. By ordering earlier, slower and less expensive freight delivery modes can be used.

• Rent temporary warehouse space to handle the bulge in inventory that accompanies the start and end of school terms.

b. Some considerations for book publishers include:

• Maximize the life cycle length of each publication so that fixed costs can be spread across more units.

• Manage the product mix so that unprofitable publications are eliminated.

• Manage the number of publications that are overseen by each editor. • Adopt labor-saving technology to improve quality and reduce labor

costs in the publishing operation. • Make professors aware that there are costs to providing teaching

supplements and that such costs must eventually be passed on to students.

• Conduct market research to determine what students and professors desire in terms of textbook features, content, and supplements. This will minimize expenditures on unprofitable and low-volume products.

• Minimize the number of drafts of each book that must be printed prior to printing the final version.

• Focus quality control on each textbook while it is in draft form to eliminate changes that are very costly to make in later stages of production.

• Consider the use of part-time editors and other employees. • Consider outsourcing those aspects of operations that can be

accomplished more efficiently and effectively by outside vendors. • Manage the purchasing of paper and other inputs to minimize handling

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costs and maximize purchase discounts.


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• Concentrate on developing JIT production capability to minimize

production of books that are currently not in demand. This will reduce storage needs and costs associated with carrying inventory.

• Adopt the latest technologies in cost management (e.g., activity-based costing).

c. Students can

• Share textbooks with a friend or acquaintance who is taking the same class. This approach can effectively cut the cost of purchasing books in half.

• Avoid purchasing supplements and other materials that are not required by the instructor.

• Purchase their required textbooks from students rather than the bookstore. This eliminates the bookstore markup.

• Purchase the paperback editions rather than hardback textbooks. • Sell textbooks to the bookstore or other wholesalers at the end of the

semester. • Use electronic versions of the textbook rather than paper versions to

eliminate publication costs. • Exert pressure on professors to eliminate the use of unnecessary

supplements. d. College textbooks are different today for three major reasons. First, the

subject matter of many disciplines has changed dramatically in the past 20 years. Second, the technology available to publishers has advanced and allows more sophisticated products to be developed. Third, the market has become extraordinarily competitive and has forced textbook publishers to offer more comprehensive products to attract and maintain market share.

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34. (From employer perspective)


Advantages Disadvantages a. Less expensive Possibly lower quality Flexibility (if not working elsewhere) Not available as much out of class Less flexible (if employed elsewhere on a full time basis)

b. Lower cost Less loyalty to the firm c. Greater availability Possibly less competence of personnel Less continuity Less expensive d. Less expensive Possibly poor quality writing Flexibility Less control over writers e. Availability Possibly lower quality work Possibly less reliable Possibly less responsive Greater possibility of theft f. Less expensive Less training Availability Possibly less loyalty Possibly poorer customer relations g. Less expensive Possibly less reliable Possibly less control Possibly lower quality of work h. Less expensive Possibly lower quality of work Possibly less reliable Possibly less control i. More alert employees Possibly lower quality of work

Less expensive Possibly less competent workers Lower pension & benefits Lack of company loyalty costs j. Provides more flexible Inconsistent work capacity Reduced ability to control Lower cost quality Availability of more workers k. Availability Potential theft Better quality of life Potential damage to relations for Mom & Pop with customers Less expensive 35. a. 7,800 x .98 = 7,644 flawless gaskets per kWh. b. Achieved efficiency per kWh = (1,390,000 – 17,900) ÷ 175 = 7,840.6 gaskets

per kWh which exceeds the standard by 196.6 flawless gaskets per kWh.

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(7,840.6 – 7,644) c. Achieved effectiveness = 17,900 ÷ 1,390,000 = 1.29% flaws, versus the

expected 2.0% rate of flaws. Thus, the machine is more effective in producing flawless output than claimed.

d. kWh at standard efficiency: [(1,390,000 – 17,900) ÷ 7,644] = 179.5 kWh. Std. kWh 179.50 Act kWh 175.00 kWh saved 4.50 Cost per kWh x $3.20 Cost savings $ 14.40 e. An automobile manufacturer would want zero defects in the gaskets it

purchases and would expect the vendor to have sufficient quality control measures to virtually ensure this.

36. a. EDP Depart- Unexpended ment Costs Actual Appropriation Appropriation Variable $ 87,750 $100,000 $12,250 Fixed 402,000 400,000 (2,000) Total $489,750 $500,000 $10,250

The EDP manager stayed within his $500,000 total appropriation even though he overspent on the fixed portion of it. Top management would not view this as a problem unless the appropriation had been granted separately for the variable and fixed components rather than on a total basis.

b. Actual output = 1,950 = 0.975 Planned output 2,000

The department was reasonably effective if the above ratio is a viable surrogate for effectiveness. However, it is somewhat problematic in this case in that management has been looking askance at the rapid expansion of EDP department services. Also, this calculation does not measure the quality of the output.

c. Actual output vs. Planned output Actual input Planned input Variable expenses efficiency: $87,750 = $45 per hour vs. $100,000 = $50 per hour 1,950 hours 2,000 hours (actual efficiency exceeds expectations) Fixed expenses efficiency: $402,000 = $206 per hour vs. $400,000 = $200 per hour 1,950 hours 2,000 hours

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(actual efficiency is slightly less) d. (1) Actual Actual Hrs. x Std Rate Hrs. Earned x Std. Rate 1,950 x $50 1,950 x $50 $87,750 $97,500 $97,500 $9,750 F $0 Spending Variance Efficiency Variance (note) $9,750 F

Total Variable EDP Cost Variance Note: Since input hours of service are all assumed to be good hours of output in this case,

there is no efficiency variance. If a separate measure of output can be devised, an efficiency variance can be calculated.

(2) Actual Budget Hrs. Earned x Std. Rate 1,950 x $200 $402,000 $400,000 $390,000 $2,000 U $10,000 U Spending Variance Volume Variance

$12,000 U Total Fixed EDP Cost Variance e. To do this, normal or anticipated hours of utilization must be specified. In

the case at hand, a first approximation can be found by dividing the current year budgeted fixed costs by the number of anticipated (budgeted) hours ($400,000 ÷ 2,000 = $200 per hour) and the budgeted variable costs by the budgeted service hours ($100,000 ÷ 2,000 = $50 per hour). Combining the fixed and variable rate ($200 plus $50), a total of $250 per hour of computer time is indicated.

It seems reasonable to believe that charging almost $250 per hour for computer time where there was no charge previously would cause a reduction in demand. A reduction in demand would cause the fixed portion of EDP department costs to be averaged over fewer hours, resulting in an even higher charge per hour. For instance, if demand could be expected to drop by 20 percent to 1,600 hours, then the fixed rate per hour would rise to $250 ($400,000 ÷ 1,600) and the total charging rate would rise to $300 per hour.

37.

• This finding represents both efficiency and effectiveness. It is primarily for cost avoidance. Use of simple, inexpensive antibiotics is found to be better treatment (more effective) and less expensive (more efficient). It is

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cost avoidance because it calls for using a lower-cost alternative.


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• This finding represents efficiency. It is primarily cost avoidance. Watchful

waiting does the job better than using expensive MRIs and is a lower cost substitute.

• This finding represents effectiveness. Medical professionals find reduced likelihood of dying from heart attacks by prescribing aspirin and/or beta blockers.

• This finding represents effectiveness. Medical professionals find that inhaled steroid medications can prevent disability and complications among asthmatic patients.

• This finding represents efficiency. It is primarily cost avoidance. Patients trained to avoid asthma triggers, measure their own lung function, follow a consistent treatment plan, and make adjustments in their own medications is a much lower cost substitute than extended hospital stays and emergency room visits.

38. a. A flexible budget allows management to directly compare the actual cost of

operations with budgeted costs for the activity achieved. It assists management in evaluating the effects of varying levels of activity on costs, profits, and cash position, thus aiding in the choice of the level of operation for planning purposes.

The flexible budgets presented are based on three different activity measures, none of which coincides with the actual level of performance for November. The budget must be restated to a level of activity that matches the actual results. The fixed and variable components of the mixed costs must be segregated and a budgeted cost calculated for the level of activity attained.

b. Sales salaries are the only cost that varies perfectly with number of

salespersons ($90,000 ÷ 100 = $900). The following vary with sales orders: Sales commissions $300 per sales order Sales travel 100 per sales order ($50,000 assumed fixed) Sales office expense 30 per sales order ($400,000 assumed fixed) Shipping expense 100 per sales order ($500,000 assumed fixed) Total Var. cost $530 per sales order

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c. Buzz Beverages


Selling Expense Report - November Monthly Expenses Budget Actual Variance Adver. & promo. $1,500,000 $1,450,000 $50,000 F Admin. salaries 75,000 80,000 5,000 U Sales salaries 1 81,000 92,000 11,000 U Sales commissions2 447,000 460,000 13,000 U Salesperson travel3 199,000 185,000 14,000 F Sales off. expense4 448,000 500,000 52,000 U Shipping expense5 660,000 640,000 20,000 F $3,410,000 $3,407,000 $ 3,000 F 1($90,000 ÷ 100) x 90 = $81,000 2($450,000 ÷ $15,000,000) x $14,900,000 = $218,800 3Change in cost: $225,000 - $200,000 = $25,000 Change in sales dollars: $17,500,000 - $15,000,000 = $2,500,000 Variable cost per dollar of sales = change in cost divided by change in activity level: $25,000÷$2,500,000 = $.01 per dollar of sales Fixed cost at $15,000,000: $200,000 - ($15,000,000 x .01) = $50,000 Total travel budget: $50,000 fixed + (14,900,000 x .01) = $199,000 (variable = $149,000) 4Change in cost: $452,500 - $445,000 = $7,500 Change in number of orders: 1,750 - 1,500 = 250 Variable cost per order: $7,500 ÷ 250 = $30 Fixed cost: $445,000 - (1,500 x $30) = $400,000 Total office expense budget: $400,000 + (1,600 x $30) = $448,000 5Change in cost: $675,000 - $650,000 = $25,000 Change in number of units: 17,500 - 15,000 = 2,500 Variable cost per unit: $25,000 ÷ 2,500 = $10.00 Fixed cost: $650,000 - (15,000 x $10.00) = $500,000 Total shipping expense budget: $500,000 + (16,000 x $10.00) = $660,000 d. Sales salaries ÷ No. of salespersons = $92,000 ÷ 90 = $1,022* variable cost *rounded

Note: to estimate the actual variable cost portion of the mixed costs, we assume the fixed portion of the mixed cost was equal to the budgeted amount.

Actual variable cost per sales order: Commissions ÷ No. of orders = $460,000 ÷ 1,600 = $287.50

Variable travel ÷ No. of orders = ($185,000 - $50,000) ÷ 1,600 = $84.38*

Variable office expense ÷ No. of orders = ($500,000 - $400,000) ÷ 1,600 = $62.50

Variable shipping expense ÷ No. of orders = ($640,000 - $500,000) ÷ 1,600 = $87.50 *rounded

e. To comment on effectiveness would require knowledge of a target sales

figure. If such a target had been less than or equal to $14,900,000, the

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salespersons could have been considered effective. Otherwise, a degree of effectiveness of less than 100% must be assigned.


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The manager of sales expenses may be considered to be slightly more than 100% efficient as evidenced by the $3,000 favorable variance presented in part c.

(CMA adapted) 39. Firms accumulate cash for three reasons: to liquidate planned transactions,

to provide for liquidation of unplanned transactions and for speculation. Internet companies may have greater needs than traditional companies in all three areas. Because many Internet companies have operating cycles that consume, rather than produce, cash, these companies must have cash available to cover cycle shortfalls. Second, Internet companies operate in a less predictable environment and must maintain cash balances sufficient to cover contingencies. Also, the Internet environment is very fluid, and Internet companies must maintain enough cash to exploit unexpected opportunities (e.g., the opportunity to purchase a weak competitor). Finally, the Internet companies may have difficulty acquiring cash from either public or private sources on reasonable terms if the firms are forced to go to capital markets under distress circumstances.

40. To: Mary Ross From: Barry Stein Subject: Explanation of November 2006 Variances a. The revenue mix variance resulted from a higher proportion of participants

being eligible for discounts. The budgeted revenue was based on 30 percent of the participants taking the discount; but, during November, 45 percent of those attending the courses received discounts. As a result, the weighted average fee dropped from $145.50 to $143.25.

b. The most significant implication of the revenue mix variance is that the proportion of discount fees has increased by 50 percent. If the increase represents a trend, the implications for future profits could be serious as revenues per participant day will decline while costs are likely to remain steady or increase.

c. The revenue timing difference was caused by early registrations for the

December program to be held in Cincinnati. The early registrations resulted from the combined promotional mailing for both the Chicago and Cincinnati programs. These early registrations have been prematurely recognized as revenue during November.

d. The revenue recognition in November of early registrations for the December courses is inappropriate, and, consequently, revenues during the month of December may be lower than expected.

e. The primary cause of the unfavorable total expense variance was additional

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food charges, course materials, and instructor fees. Although these quantity variances are unfavorable, the increased costs of $10,400 are more than offset by the additional revenues of $40,740 with which these items are associated.


f. The favorable food price variance was determined by multiplying the

difference between the budgeted and actual price per participant day times the actual participant days. The actual price per participant day was determined by dividing the actual food charges by the total participant days ($32,000 ÷ 1,280).

g. While the combined promotional piece had a $5,000 unfavorable impact on November expenses, there will be no need for further promotion of the Cincinnati program. Therefore, the $20,000 budgeted for this purpose in December will not be expended, lowering planned expenses for the month. The promotion timing difference represents an incorrect matching of costs and revenue. The costs allocated to the Cincinnati program should be reflected on the December statement of operations to be matched against the December program.

h. The course development variance is unfavorable to the November budget, but its overall impact on the company cannot be determined until such time as the level of acceptance of the new course is experienced.

(CMA adapted) 41. a. The use of part-timers is obviously an effective cost control technique. The

firm is able to avoid incurring the fringe benefit and other indirect costs associated with full time employees. Further, using part-timers allows the firm to expand and contract capacity to avoid the generation of idle resources that are normally found in a seasonal business.

b. If there are qualitative differences between those workers who are willing

to work part time and those who are only willing to work full time, these qualitative differences may be impounded in the work they perform. However, the quality of the work performed by paraprofessionals should be controllable through careful supervision and careful selection of tasks.

c. It is unlikely that part-timers and paraprofessionals, used in lieu of full time

professionals, can enhance the effectiveness of public accounting firms. It is much more likely the case that they are hired on the grounds of efficiency. The paraprofessionals and part-timers are a less expensive input than full-time professionals to the various service activities conducted in public accounting firms.

42. a. The controller would likely support the procurement of such a system

because it would allow controller functions to be executed more efficiently, and possibly, at a higher level of quality. The improvement in efficiency would arise incidental to the elimination of the paper documents involved in purchasing processes (e.g., purchase order) and payment processes

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(e.g. checks). The improvement in quality would arise from eliminating points in the process in which human error can be introduced, for example, manually transferring information from a material requisition form onto a purchase order.


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Any reluctance on the part of the controller would likely be related to the need

to develop new controls to maintain the security of the procurement process.


b. The VP of product development would likely oppose implementing the

system. Perhaps more so than other executives in the firm, the VP of product development benefits from interacting directly and personally with vendors. It will be difficult in an e-procurement system to replicate the richness of information exchanges that occur in face-to-face conversations, or even phone conversations. Thus, to the extent that many innovative product ideas arise among vendors, the flow of those ideas might be stymied with the implementation of an e-procurement system.

43. a. There are two general types of recommendations that could be made to Mr. Sharp. First, one could recommend to Mr. Sharp that forecasting models for energy costs be improved. To aid in this process, a statistician or econometrician could be hired to improve existing forecast models. Second, some or all of the uncertainty regarding the price of energy could be eliminated by utilizing forward contracts or hedging strategies. Accordingly, a recommendation should be made to Mr. Sharp to consider implementing such a strategy.

b. The management of energy costs should have two focal points. One focus

should be on managing the price of energy. Better use of forward contracts and hedging strategies would be useful to manage the price of energy. The second focus would be on managing the usage of energy. The usage of energy can be controlled by managing the efficiency with which energy is consumed and by using the most economical energy sources.

44. 1. The financing costs of inventory have two sources of risk. First, is the

value of inventory to be financed and the length of time the inventory must be financed; second is the interest rate paid to obtain the financing. The value of inventory to be financed can be reduced by moving to JIT production, or at at a minimum, deferring the buildup of inventory until later in the year. The interest rate paid to borrow funds to finance the inventory can be controlled through hedging strategies involving the use of futures contracts or by entering into long-term agreements with lenders.

2. The cost of resin also has two main risk factors. One is the quantity of

resin to be acquired and the other is the price per unit to be paid for the resin. The quantity of resin is best controlled by effectively managing the efficiency of operations and correctly forecasting the quantity of resin to be consumed. The price risk is best managed by entering into forward contracts or by hedging using futures contracts (if available).

3. “Acts of Nature” are, by definition, impossible or nearly impossible to

predict; i.e., these events occur on a random basis. Accordingly, purchasing insurance is the best approach for managing this risk.

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4. Price uncertainty for products produced can be managed by entering into

long-term contracts with customers, or by purchasing futures contracts (technically, the firm would be short selling contracts) to protect against price declines.


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5. Uncertainty regarding demand for the company’s products is best dealt

with by eliminating some of the uncertainty by improving managers’ understanding of the demand drivers for the company’s products. Doing so will allow the company to develop better forecasts of demand. Better forecasts will allow the company to improve the relationship between production volume and sales volume and reduce the risks of obsolete inventory as well as stock outages.

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