ACCT 2102 1st Edition Lecture 31 Outline of Last Lecture I Review II Segmented Income Statement III ROI and RI IV ROI and RI Example Outline of Current Lecture V ROI and RI Example 2 VI Standard Cost VII Flexible Budgets and Variances VIII Direct Materials Variances IX Direct Materials Variances Example Current Lecture Standard Costs and Variances Chapter 11 Finishing Chapter 10 Review Hurdle rate Minimum rate company will accept for an investment Maximize goal congruence incentivize the manager to accept investment not acting in company s best interest if he she does not accept it RI fosters goal congruence V ROI and RI Example 2 Selected data from the prior period operations of Brutus and Nero two investment centers for Madam Medusa s Boutique are as follows Operating Income Sales Revenue Total Assets Brutus 36 000 600 000 200 000 Nero 32 000 800 000 200 000 Each manager is presented with an 100 000 investment opportunity that will generate operating income of 17 000 The company s target rate of return is 15 Investment s return is 17 17 000 100 000 These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute Compute the ROI and RI for each Brutus ROI 36 000 200 000 18 Brutus RI 36 000 200 000 15 6 000 Nero ROI 32 000 200 000 16 Nero RI 32 000 200 000 15 2 000 Determine if the managers will accept the investment opportunity assuming 1 They will receive a bonus based solely on their ability to exceed their division s prior period return on investment Brutus ROI 18 Nero ROI 16 Target 17 Reject Brutus since 17 18 and we want Brutus to exceed the prior return Accept Nero since 17 16 2 They will receive a bonus based solely on their ability to exceed their division s prior period residual income Brutus RI 6 000 Nero RI 2 000 17 000 100 000 15 2 000 Accept Brutus and Nero Investment will have positive RI since 17 15 Now for Chapter 11 VI How much should it cost to produce one unit A standard cost is a mini budget for a single unit of product Standards are used at the beginning of the period to help with the budgeting process Standards are used at the end of the period to evaluate performance and help control future costs Standards are developed for DM DL and MOH We will focus on the two direct product cost categories Direct Material Standard DM Cost per Unit Standard Quantity of DM x Standard Price of DM If a unit requires 2 pounds of DM and the DM costs 5 per pound from the supplier what is the standard DM cost per unit o Standard quantity 2 pounds o Standard DM Cost per Unit 2 lbs unit x 5 lb 10 unit Direct Labor Standard DL Cost per Unit Standard Quantity of DL x Standard Rate of DL If a unit requires 5 hours of DL and the DL wage rate if 10 per hour what is the standard DL cost per unit o Standard DL Cost per Unit Hours unit x wage rate o Standard DL Cost per Unit 5 hrs unit x 10 hr 50 unit The standard quantity of input is also referred to as an input ratio VII VIII Flexible Budgets and Variances at the end of the period Remember that the Flexible Budget Variance can be further divided into a Price Variance and a Quantity Variance Each variance can be labeled as either Favorable F or Unfavorable U What do these mean Price Rate Variance o Price relates to DM o Rate relates to DL o Compares what we paid to what we expected to pay o U pay more than expected o F pay less than expected Quantity Efficiency Variance o Quantity relates to DM o Efficiency relates to DL o Compares what we used to what we expected to use during production o U used more than expected o F use less than expected Should we only investigate unfavorable variances No Should investigate all variance that are material Direct Materials Variances DM Price Variance o What is it What you expected to pay compared to what you paid o When can it be calculated At the point of purchase at the earliest o Who is responsible for it Purchasing manager o DM price qty purchased act price std price o qty purchased act price qty purchased std price qty purchased act price total dollar amount of purchase DM Quantity Variance o What is it What you expected to use compared to what you used o When can it be calculated At the point of production o Who is responsible for it Production manager o DM qty std price qty used qty allowed Qty allowed qty should have used for actual level of output o DM qty std price qty used output input ratio Total DM Variance IX DM Variances example Leave Only Footprints Inc manufactures lightweight sleeping bags During the previous period 104 000 pounds of direct material were used to produce 20 000 sleeping bags 106 000 pounds of direct material were purchased during the period at a total cost of 333 900 The company anticipated the direct material cost of each sleeping bag to be 16 and the cost of each pound of direct material to be 3 20 What do the numbers mean 104 000 qty used 106 000 qty purchased 20 000 output 333 900 total amount of purchase 3 20 std price 16 std unit cost not used in formulas 333 900 106 000 3 15 actual price 16 3 20 5lbs unit input ratio Calculate all DM variances Assuming all variances are material provide a likely explanation for each variance DM price qty purchased act price std price DM price 106 000 333 900 106 000 3 20 DM price 5 300 F DM qty std price qty used qty allowed DM qty 3 20 104 000 20 000 5 DM qty 12 800 U F negative U positive