CHAPTER 11

Budgetary CONTROL AND RESPONSIBILITY ACCOUNTING

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, BLOOM’S TAXONOMY, LEVEL OF DIFFICULTY, AACSB CODES, AND CPA CODES

Bloom’s: AN = Analysis AP = Application C = Comprehension

E = Evaluation K = Knowledge

LOD: E = Easy M = Medium H = Hard

AACSB: AN = Analytic

CPA: MA = Management Accounting

*This topic is dealt with in an Appendix to the chapter.

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, BLOOM’S TAXONOMY, LEVEL OF DIFFICULTY, AACSB CODES, AND CPA CODES (CONT’D)

Bloom’s: AN = Analysis AP = Application C = Comprehension

E = Evaluation K = Knowledge

LOD: E = Easy M = Medium H = Hard

AACSB: AN = Analytic

CPA: MA = Management Accounting

*This topic is dealt with in an Appendix to the chapter.

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, BLOOM’S TAXONOMY, LEVEL OF DIFFICULTY, AACSB CODES, AND CPA CODES (CONT’D)

Bloom’s: AN = Analysis AP = Application C = Comprehension

E = Evaluation K = Knowledge

LOD: E = Easy M = Medium H = Hard

AACSB: AN = Analytic

CPA: MA = Management Accounting

*This topic is dealt with in an Appendix to the chapter.

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE

Note: TF = True-False C = Completion BE = Brief Exercise

MC = Multiple Choice Ex = Exercise SAE = Short-Answer Essay

Ma = Matching

*This topic is dealt with in an Appendix to the chapter.

CHAPTER LEARNING OBJECTIVES

1. Describe budgetary control and static budget reports.

Budgetary control consists of (1) preparing periodic budget reports that compare actual results with planned objectives, (2) analyzing the differences to determine their causes, (3) taking appropriate corrective action, and (4) modifying future plans, if necessary.

Static budget reports are useful for evaluating the progress toward planned sales and profit goals. They are also good for assessing a manager’s effectiveness in controlling fixed costs and expenses when (1) actual activity closely approximates the master budget activity level, and/or (2) the costs respond to changes in activity in a fixed way.

2. Explain the development of flexible budgets and the usefulness of flexible budget reports.

To develop the flexible budget, it is necessary to do the following:

1. Identify the activity index and the relevant range of activity.
2. Identify the variable costs and determine the budgeted variable costs per unit of activity for each cost.
3. Identify the fixed costs and determine the budgeted amount for each cost.
4. Prepare the budget for selected increments of activity within the relevant range.

Flexible budget reports permit an evaluation of a manager's performance in controlling production and costs.

3. Apply responsibility accounting to cost and profit centres.

Responsibility accounting involves accumulating and reporting revenues and costs that involve the individual manager who has the authority to make the day-to-day decisions about the cost items. The evaluation of a manager's performance is based on the matters directly under the manager's control. In responsibility accounting, it is necessary to distinguish between controllable and non-controllable fixed costs and to identify three types of responsibility centres: cost, profit, and investment.

Responsibility reports for cost centres compare actual costs with flexible budget data. The reports show only controllable costs, and no distinction is made between variable and fixed costs.

Responsibility reports show contribution margin, controllable fixed costs, and controllable margin for each profit centre.

4. Explain the basis and formula used for evaluating performance in investment centres.

The primary basis for evaluating performance in investment centres is return on investment (ROI). The formula for computing ROI for investment centres is as follows: controllable margin ÷ average operating assets.

*5. Explain the difference between ROI and residual income (Appendix 11A).

ROI is controllable margin divided by average total assets. Residual income is the income that remains after subtracting the minimum rate of return on a company’s average operating assets. ROI sometimes provides misleading results because profitable investments are often rejected if they would reduce the ROI but increase overall profitability.

TRUE-FALSE STATEMENTS

1. Budget reports comparing actual results with planned objectives should be prepared weekly to be most effective.

2. Cash budget reports are often prepared daily: whereas, others are prepared less frequently depending on the activities being monitored.

3. The master budget is the basis of developing flexible budgets.

4. Evaluating a manager's performance in controlling variable costs is effectively achieved using a static budget.

5. The amount of fixed costs, which appear on the flexible budget is the same as those appearing on the master budget.

6. The activity index used in preparing a flexible budget should be the basis of the variable costs that are being budgeted.

7. A formula used in developing a flexible budget is: Total budgeted cost = fixed cost + (total variable cost ÷ activity level).

8. Management by exception means that management will investigate all areas where actual results are greater than planned results.

9. Direct fixed costs are synonymous with common costs.

10. Cost centre managers are evaluated on the profitability of their centres.

11. Operating assets include all those listed under Assets on an investment centre’s balance sheet.

*12. Residual income and ROI are used as performance evaluation methods for profit centre performance.

ANSWERS TO TRUE-FALSE STATEMENTS

MULTIPLE CHOICE QUESTIONS

13. A static budget

a) is one that is geared to the most profitable level of activity for a company.

b) is a projection of budget data at various levels of activity.

c) considers that actual activity is often different from the level of activity expected.

d) is a projection of budget data at one level of activity.

14. Which one of the following statements describes a budget report?

a) It is the preparation of long-term plans.

b) It is a comparison of actual results with planned objectives.

c) It includes the valuation of inventories.

d) It is voted on and approved by the shareholders.

15. How often should a company prepare budget reports?

a) as often as demanded by the shareholders

b) as often as deemed necessary

c) annually is sufficient if the company is profitable

d) monthly to be sure the company is operating successfully

16. Which one of the following do budget reports provide for managers?

a) the cause of differences between actual and projected amounts

b) the nature of corrective action needed

c) feedback on operations

d) modification actions necessary

17. What is the purpose of a departmental overhead cost report?

a) to control corporate labour costs

b) to allocate uncontrollable costs

c) to determine the cause of any misuse of costs

d) to control overhead costs

18. What is the purpose of the sales budget report?

a) to control the cost of selling products in a company

b) to assess whether the company is profitable or not

c) to determine why sales goals were met or not met

d) to identify differences between planned sales and actual sales and take corrective action if necessary

19. Which one of the statements below is correct concerning the comparison of differences between actual and planned results?

a) The difference must be reported on external financial statements.

b) The differences always require investigation.

c) It reflects information from the static budget.

d) It enables managers to take corrective action when differences are material.

20. Which one of the following is true concerning a static budget?

a) It is prepared at the end of the accounting period once actual results are known.

b) It is useful in evaluating a manager's performance by comparing actual variable costs and planned variable costs.

c) It shows planned results at the original budgeted activity level.

d) It reflects the level of activity at which the company will be most profitable.

21. When is a static budget most appropriate in evaluating a manager's performance?

a) When the actual costs incurred equal the amounts in the budget.

b) When the actual activity is less than the master budget activity.

c) When the company performed at the same activity level as the static budget level.

d) The static budget is not appropriate for evaluating managers.

22. Which statement is true concerning a static budget report?

a) It considers performance at numerous activity levels.

b) It is appropriate in evaluating a manager's effectiveness in controlling fixed costs.

c) It should be used when the actual level of activity is materially different from the master budget activity level.

d) It is most effective when evaluating a manager's effectiveness in controlling variable costs.

23. What exists when budgeted costs exceed actual results?

a) a budgeting error

b) a favourable difference

c) an unfavourable difference

d) an excess profit

24. What should be the reaction of upper level managers when a difference between budgeted and actual sales exists?

a) The difference should be investigated if it is unfavourable.

b) The difference should be ignored since economic conditions affect sales and cannot be controlled by the company’s managers.

c) It depends on whether the difference is material or not.

d) It depends on management personalities.

25. A manager determined that certain costs were NOT responsive to changes in activity level. What are these costs?

a) mixed

b) flexible

c) variable

d) fixed

26. Dunellon Company’s actual sales results exceeded the planned results for February. This amount exceeded the amount of an unfavourable difference reported for January sales. Which one of the following statements about the sales budget report for the two months ending February 28 is true?

a) The sales report is not useful since it shows a favourable and unfavourable difference for the two months.

b) The differences for the two months will offset each other so the differences should not be a concern.

c) The difference for February can be ignored since it is favourable.

d) The differences for both months should be investigated if the amounts are material.

27. For which of the following costs is a static budget most appropriate?

a) uncontrollable costs

b) manufacturing costs

c) fixed overhead costs

d) variable overhead costs

28. Which one of the following is another name for the static budget?

a) flexible budget

b) operating budget

c) permanent budget

d) master budget

29. Yellow Card Company compared its actual sales results with a static budget. Which of the following situations might result?

a) favourable differences that are not justified

b) unfavourable differences that are not justified

c) either favourable or unfavourable differences that are not justified

d) actual differences that are justified

30. In what situations will a static budget be most effective in evaluating a manager's effectiveness?

a) When the company has substantial fixed costs.

b) When the company has substantial variable costs.

c) When the planned activity levels match actual activity levels.

d) When the company has no fixed costs.

31. Which one of the following is a reason that a company may have significant deviations from budgeted performance?

a) Actual results were compared to flexible budget amounts instead of static budget amounts.

b) The budget was approved by the budget committee.

c) Economic conditions may have changed since the plan was developed.

d) A company has substantial variable costs.

32. Budgetary control means

a) that once a budget is agreed to by management there can be no deviation from it.

b) that once a budget is agreed to the controller of the company is now in charge of cost and profit controls.

c) that the difference between actual results and budgeted results are reported and assessed over time.

d) that the budget can be changed during the year to reflect actual results.

33. A static budget offers management the best results when

a) variable material costs are fixed by suppliers to the company.

b) fixed selling costs are established at the start of the budget process.

c) fixed manufacturing costs are established at the start of the budget process.

d) fixed manufacturing, selling, and administrative costs are established at the start of the budget process.

34. A characteristic of a good budget is

a) that it is easy to understand by top management.

b) that is encompasses every account in the firm’s accounting system.

c) that management is satisfied that it will provide shareholders with an adequate return on their investment.

d) that it is easy to understand and communicate to all within the firm.

35. Kilroy Manufacturing prepared a 2022 budget for 40,000 units of product. Actual production in 2022 was 41,000 units. Which one of the following is the most useful comparison for this company?

a) the actual results for 41,000 units with a new budget for 41,000 units

b) the actual results for 41,000 units with the original budget for 40,000 units

c) the actual results for 41,000 units with the previous year’s actual results for 44,000 units

d) It does not matter. All of these choices are equally useful.

36. What is the primary difference between a static budget and a flexible budget?

a) The static budget contains only fixed costs, while the flexible budget contains only variable costs.

b) The static budget is prepared for a single level of activity, while a flexible budget is adjusted for different activity levels.

c) The static budget is constructed using input from only upper level management, while a flexible budget obtains input from all levels of management.

d) The static budget is prepared only for units produced, while a flexible budget reflects the number of units sold.

37. A flexible budget

a) is not as useful in evaluating a manager's performance as a static budget.

b) can be prepared for each of the types of budgets included in the master budget.

c) relies on the assumption that unit fixed costs will remain constant within the relevant range of activity.

d) reflects budget data for one level of activity only.

38. A flexible budget

a) is not based on the master budget.

b) is widely used in production departments and least used in service departments.

c) report will compare actual costs with the budgeted costs at the actual activity level achieved.

d) cannot be prepared for each of the types of budgets included in the master budget.

Use the following information to answer questions 39–43.

EKPN Company prepared the following data in its static budget based on 150,000 machine hours:

Direct Materials $ 450,000

Direct Labour 225,000

Variable Overhead 1,125,000

Fixed Overhead 2,100,000

Actual Results:

Machine Hours 160,000 hours

Direct Materials $ 475,000

Direct Labour 245,000

Variable Overhead 1,150,000

Fixed Overhead 2,110,000

39. What was the budgeted variable costs per machine hour for variable overhead, rounded to the nearest whole cent?

a) $7.03/machine hour

b) $7.50/machine hour

c) $19.53/machine hour

d) $20.83/machine hour

40. What is the budgeted direct labour cost at the actual level of activity?

a) $245,000

b) $240,000

c) $210,938

d) $20,000

41. What is the budgeted fixed overhead at the actual level of activity?

a) $2,100,000

b) $2,110,000

c) $2,240,000

d) $3,260,000

42. What was the difference between the actual and budgeted direct material costs at the actual level of activity?

a) $25,000 unfavourable

b) $25,000 favourable

c) $5,000 unfavourable

d) $5,000 favourable

43. What possible reason could explain the difference between the actual fixed overhead costs and the budgeted fixed overhead costs?

a) EKPN Company’s actual machine hours were greater than the budgeted amount.

b) EKPN Company’s actual machine hours were less than the budgeted amount.

c) EKPN Company spent more on fixed costs than it expected.

d) EKPN Company spent less on fixed costs than expected.

44. Which one of the following is true of a flexible budget?

a) It is prepared when managers are unsure of activity levels.

b) It projects budget data at a pre-planned level of activity.

c) It is useful in controlling variable and fixed costs.

d) It shows no differences between actual and budgeted amounts because it is prepared after the actual results are determined.

45. Haroot Company’s master budget shows that the planned activity level for next year is expected to be 20,000 machine hours. At this level of activity, the following manufacturing overhead costs are expected:

Indirect labour $45,000

Factory supplies 4,000

Indirect materials 21,000

Depreciation on factory building 15,000

Total manufacturing overhead $85,000

Indirect labour, factory supplies, and indirect materials are variable costs. If the company operates at 21,000 machine hours, how much is allowed on a flexible budget for manufacturing overhead costs?

a) $89,250

b) $73,500

c) $88,500

d) $85,000

46. A department has budgeted monthly fixed manufacturing overhead cost of $40,000 plus $5 per direct labour hour. The flexible budget report reflects $120,000 for total budgeted manufacturing cost for the month. What is the budgeted level of activity to be achieved during the month?

a) 32,000 direct labour hours

b) 24,000 direct labour hours

c) 16,000 direct labour hours

d) cannot be determined

47. Which one of the following would be the same total amount on a flexible budget and a static budget if the activity level is different for the two types of budgets?

a) direct labour cost

b) indirect labour cost

c) fixed manufacturing overhead

d) variable manufacturing overhead

48. Which one of the following statements is true in developing a flexible budget within a relevant range of activity?

a) The budget must reflect a fixed level of activity.

b) Total variable costs should be adjusted based on the activity index chosen.

c) Costs cannot increase when different levels of activity exist.

d) Fixed costs are not reported.

49. Which one of the following statements is true concerning a flexible budget?

a) It is prepared once the actual activity level is determined.

b) It is relevant both within and outside the relevant range.

c) It replaces a master budget.

d) It is one of the financial budgets.

50. For which of the budgets in the master budget can a company prepare a flexible budget?

a) only the sales budget

b) only the income statement budget

c) only the budgets that reflect operations

d) all of the budgets

51. Surf N Waves planned to sell 27,000 surfboards; however, the actual number sold totalled 23,000. Which one of the following provides the best comparison of the cost data associated with the sales?

a) a budget based on the original planned level of activity

b) a budget of 27,000 units of activity

c) a budget of 23,000 units of activity

d) the master budget level of activity

52. What assumption about the behaviour of total costs occurs within the relevant range of activity?

a) linear and upward sloping

b) linear and downward sloping

c) curvilinear and upward sloping

d) horizontal

53. Which statement is true concerning the selection of the level of activity used in the flexible budget?

a) The activity level should be the same as actually achieved.

b) The activity level should be the same as found in the master budget.

c) Any activity level can be used in the flexible budget.

d) The activity level should be at the level that maximizes profit.

54. Which statement is true concerning management by exception?

a) It causes employee morale problems.

b) It requires that all differences will be investigated.

c) It requires management to investigate only unfavourable differences.

d) It requires investigation of all material differences whether favourable or not.

55. Nextel Communications uses management by exception. Which differences between planned and actual results will it investigate?

a) those that are material and non-controllable

b) those that are controllable and non-controllable

c) those that are material and controllable

d) All differences should be investigated.

56. How does a graph of a flexible budget compare to a CVP graph?

a) Fixed costs appear differently.

b) Variable costs appear differently.

c) Sales revenues are not shown on a flexible budget graph.

d) The two are graphed identically.

57. Which statement is true about the activity index used in preparing the flexible budget?

a) It applies only to fixed manufacturing costs.

b) It is the same for all departments of the company.

c) It significantly influences the variable costs that are being budgeted.

d) It is irrelevant to total costs.

58. Which statement is true concerning management by exception?

a) It is most effective on uncontrollable costs.

b) It enables management to focus on problem areas.

c) It allows managers to decide when they want to use budget guidelines.

d) It allows managers to concentrate on the uncontrollable costs.

59. Roasted Toasters prepared a 2022 budget for 40,000 units of product. Actual production in 2022 was 45,000 units. To be most useful, what amounts should a performance report for this company compare?

a) the actual results for 45,000 units with the original budget for 40,000 units

b) the actual results for 45,000 units with a new budget for 45,000 units

c) the actual results for 45,000 units with last year’s actual results for 47,000 units

d) It does not matter. All of these choices are equally useful.

60. What budgeted amounts appear on the flexible budget?

a) original budgeted amounts at the static budget activity level

b) actual costs for the budgeted activity level

c) budgeted amounts for the actual activity level achieved

d) actual costs for the estimated activity level

61. TrueMasons’ budgeted costs for 25,000 linear metres of block are:

Fixed manufacturing costs $12,000 per month

Variable manufacturing costs $16.00 per linear metre

True Masons installed 20,000 linear metres of block during March. How much is total manufacturing costs in March on TrueMason’s flexible budget?

a) $320,000

b) $412,000

c) $400,000

d) $332,000

62. Flexible budgets imply

a) that sales managers can have a wide latitude in modifying prices during the year.

b) that a firm will have different levels of activity and costs during a year.

c) the budget process may not be accurate at the beginning of the budget year.

d) each manager is free to change the budget as the year progresses.

63. When setting a flexible budget, it is important to know

a) the expected profit that a firm requires.

b) the expected return that the shareholders or owners require.

c) the relevant ranges of activity and cost.

d) the impact of inflation on the budget in the year to come.

64. Which of the following is true?

a) The evaluation of performance should be based on both uncontrollable and controllable costs.

b) Fewer costs become controllable as one moves up to each higher level of managerial responsibility.

c) Fewer costs are controllable as one moves down to each lower level of managerial responsibility.

d) Since a profit centre is an independent entity, all fixed costs are controllable by its manager.

65. Under responsibility accounting,

a) both controllable and non-controllable costs receive the same attention.

b) cost centres are NOT classified as responsibility centres since there is no revenue responsibility.

c) as one moves up each level of responsibility in an organization, the responsibility reports become more detailed.

d) a manager’s performance is evaluated based on matters that are directly under that manager’s control.

66. Perot Manufacturing reported the following items for 2022:

Income tax expense $ 40,000

Contribution margin 125,000

Controllable fixed costs 30,000

Interest expense 10,000

Total operating assets 475,000

How much is controllable margin?

a) $125,000

b) $95,000

c) $85,000

d) $45,000

67. What is the preparation of reports for each level of responsibility in the company’s organization chart called?

a) static reporting

b) responsibility reporting

c) exception reporting

d) master budgeting analysis

68. When is a cost considered to be controllable?

a) only when the manager has the power to incur the cost within a given time period

b) only if the cost is less than the budget amount

c) only when it is a variable cost

d) only when the amount changes based on different activity levels

69. Which one of the following decreases the controllability of a particular cost?

a) moving up to higher levels of managerial responsibility

b) an increase in the responsibility for costs incurred

c) a greater number of costs in a manager’s division

d) moving down to lower levels of management

70. Which one of the following describes a responsibility report?

a) It is prepared using the CVP income statement format.

b) It shows all costs that relate to a particular manager’s division.

c) It shows only the variable costs in a manager’s division.

d) It is prepared at the highest level of managerial responsibility.

71. What centres receive responsibility reports containing budgeted and actual controllable revenues and costs?

a) investment centres

b) profit centres

c) cost centres

d) investment, profit, and cost centres

72. In which situation is responsibility accounting especially valuable?

a) when large amounts of uncontrollable costs exist

b) in not-for-profit companies

c) in decentralized companies

d) in cost centres

73. Which of the following is a true statement?

a) All costs are controllable at some level with a company.

b) Responsibility accounting applies to only profitable divisions and segments.

c) A cost is controllable if it is incurred in a manager’s division or segment.

d) More costs are controllable as one moves downward in management levels.

74. What is a segment?

a) a non-controllable cost

b) an area of responsibility in decentralized operations

c) another name for a cost centre

d) a division which contains both controllable and non-controllable costs

75. Which type of centre is the toy department in a Wal-Mart store?

a) an exception centre

b) a profit centre

c) a cost centre

d) an investment centre

76. Which type of centre is the theme park division of Walt Disney Company?

a) not a responsibility centre

b) a profit centre

c) a cost centre

d) an investment centre

77. Which type of centre is the housekeeping department of a hotel?

a) a segment

b) a profit centre

c) a cost centre

d) an investment centre

78. Which of the following correctly indicates the responsibilities of the respective centre?

a) An investment centre incurs costs, and controls investment funds.

b) A cost centre incurs costs.

c) A profit centre incurs costs and controls investment funds.

d) None of these indicate the correct responsibilities.

79. Which statement is true concerning a cost centre?

a) It incurs costs and generates revenues.

b) It only exists in companies in which costs exceed revenues.

c) It is evaluated most effectively using ROI.

d) It is usually a production or service department.

80. How is a manager of a profit centre evaluated?

a) On the profit that the centre generates.

b) On his or her ability to control costs.

c) On .the amount of return the centre’s assets generate

d) On the amount of revenue that can be generated.

81. Which one of the following is a suitable way to evaluate cost centres?

a) Compare the actual profit generated with expected profit.

b) Compare actual total costs with flexible budget data.

c) Compare actual controllable costs with static budget data.

d) Compare actual controllable costs with flexible budget data.

82. What would you expect to find in a performance report for a cost centre?

a) both controllable and non-controllable costs

b) variable, but not fixed costs

c) only costs controllable by the managers of the centre

d) only material and labour costs

83. Of the following choices, which one is a common fixed cost?

a) profit centre manager's salary

b) salesclerks’ salaries

c) costs from a central payroll department to create paycheques for a cost centre's employees

d) depreciation on a responsibility centre's equipment

84. Which of the following is an indirect fixed cost?

a) depreciation on a profit centre’s machinery

b) depreciation on the company’s building, which houses several profit centres

c) health insurance costs for employees

d) profit centre supervisory salaries

85. Which one of the statements about a responsibility report is correct?

a) It contains controllable and non-controllable costs.

b) It compares actual costs with static budget data.

c) A distinction is made between variable and fixed costs.

d) It is used to evaluate investment centres, but not cost or profit centres.

86. Which one of the following is a measure of the performance of the manager of a profit centre?

a) ROI

b) success in meeting budgeted goals for non-controllable costs

c) amount of controllable margin generated

d) amount of residual income generated

87. What is controllable margin?

a) contribution margin less controllable fixed costs

b) sales minus variable costs

c) sales minus contribution margin

d) contribution margin less all fixed costs

88. For what purpose is controllable margin most useful?

a) preparing the master budget

b) performance evaluation of profit centres

c) break-even analysis

d) evaluating cost centres

89. Which of the following will most likely result in a favourable controllable margin difference?

a) sales exceeding budget; costs under budget

b) sales exceeding budget; costs over budget

c) sales under budget; costs under budget

d) sales under budget; costs over budget

90. Given below is a portion of Swinging Tunes, Inc.’s management performance report:

Budget Actual Difference

Contribution margin $1,040,000 $1,020,000 $20,000

Controllable fixed costs 430,000 420,000 10,000

Which statement is true about the manager’s overall performance?

a) The manager’s performance is above expectations.

b) The manager’s performance is below expectations.

c) The manager was under budget on all controllable and uncontrollable amounts.

d) The manager's overall performance cannot be determined from information given.

91. Which one of the following is a performance indicator for an investment centre, but NOT for a profit centre?

a) controllable margin

b) asset utilization effectiveness

c) revenues

d) controllable costs

92. Given below is an excerpt from a management performance report for a profit centre:

Budget Actual Difference

Contribution margin $600,000 $580,000 $20,000

Controllable fixed costs $200,000 $220,000 $20,000

How well did the manager perform overall?

a) $20,000 below expectations

b) $40,000 below expectations

c) equal to expectations

d) The ROI needs to be known for a total assessment.

93. What will you expect to find on a responsibility report for a profit centre?

a) only direct costs

b) no indirect fixed costs

c) all fixed costs—both controllable and non-controllable

d) controllable margin

94. How do controllable margin and contribution margin differ?

a) The amount of the controllable margin is larger than contribution margin.

b) The amount of the contribution margin is usually higher than the controllable margin.

c) The terms are synonymous.

d) Controllable margin is used for profit centres, while contribution margin is used for cost centres.

95. What is a profit centre?

a) a division of a company that has never incurred a loss

b) a responsibility centre that incurs costs and generates revenues

c) a centre evaluated by the rate of return earned on the assets allocated to the centre

d) a division of the company that has fewer costs than the other divisions

96. Which one of the following is NOT controllable by a profit centre manager?

a) variable costs

b) sales

c) controllable margin

d) assets used by the centre

97. Which statement is true concerning direct fixed costs?

a) They also called traceable costs.

b) Profit centre managers are not able to control them.

c) The often apply to more than one centre.

d) They are added to controllable margin on a responsibility report.

98. What is another name for an indirect fixed cost?

a) a traceable fixed cost

b) a controllable fixed cost

c) a segment fixed cost

d) a common fixed cost

99. Which one of the following statements about a profit centre responsibility report is correct?

a) It shows budgeted and actual controllable revenues and costs.

b) Non-controllable fixed costs are reported.

c) It provides the same information as a cost centre responsibility report.

d) All fixed costs are deducted from controllable margin.

100. EKPN Company recorded the following operating data:

Sales $1,250,000

Contribution margin 485,000

Total direct fixed costs 400,300

Total operating assets Jan. 1, 2022 750,000

Total operating assets Dec. 31, 2022 790,000

EKPN Company’s desired return 12%

What is EKPN Company’s controllable margin?

a) $849,700

b) $765,000

c) $410,000

d) $84,700

101. For which of the following is an investment centre manager responsible?

a) invested assets, sales, and costs

b) sales, profits, and invested assets

c) sales, invested assets, and assets

d) revenues and costs

102. For which of the following is a profit centre manager responsible?

a) invested assets, sales, and costs

b) sales, profits, and invested assets

c) sales, invested assets, and assets

d) revenues and costs

103. Ginder Company operates four plants, each in separate divisions, and a separate corporate office. Which one of the following would you NOT expect to find on a responsibility report for the VP of production of the company’s Eastern plant?

a) material costs for the Eastern plant

b) indirect labour of the Eastern plant

c) asset maintenance costs of factory equipment in the Eastern plant

d) interest expense on corporate company debt

104. Which responsibility centres generate both revenues and costs?

a) investment and profit centres

b) profit and cost centres

c) cost and investment centres

d) only profit centres

105. Ed is the manager of the Montreal location of Books Galore. Which one of the following would most likely be an uncontrollable cost for Ed?

a) workers’ compensation insurance expense for his cashiers

b) installation of a corporate-wide satellite dish system for book signings by selected authors

c) costs of printing signs for local promotions

d) colour selection of logo merchandise

106. In a cost centre,

a) managers are expected to control costs directly under their control.

b) managers are expected to control all costs, including allocated costs from head office.

c) managers are expected to control all direct costs and the contribution margin that they provide.

d) managers are expected to control all costs and sales from their division.

107. Responsibility centres in a decentralized organization

a) do not include cost centres.

b) do not include profit centres.

c) only include investment centres.

d) include cost, profit, and investment centres.

108. Which of the following is true?

a) ROI is the primary basis for evaluating profit and investment centre managers.

b) Increasing the average operating assets can increase ROI.

c) Increasing either controllable margin or the average operating assets can raise ROI.

d) When ROI is calculated, management would prefer a high percentage.

109. Investment centres

a) rarely generate revenues by selling products.

b) generate a return on operating assets.

c) are not often associated with product lines and subsidiary companies.

d) are solely evaluated on the rate of return earned on the funds invested.

110. The area manager of the Steak House Restaurants is considering two possible expansion alternatives. The required investments, expected controllable margins, and the ROIs of each are as follows:

Project Investment Controllable Margin ROI

Winnipeg $300,000 $100,000 33.33%

Regina $700,000 $200,000 28.57%

The Steak House segment has currently $5,000,000 in invested capital and a controllable margin of $1,500,000. Which one of following projects will increase the Steak House division’s current ROI?

a) both the Winnipeg and Regina options

b) only the Winnipeg option

c) only the Regina option

d) neither the Winnipeg nor the Regina options

111. What is the purpose of determining return on investment?

a) to assess a company’s controllable margin

b) to determine which costs are controllable

c) to assess performance of an investment centre

d) to determine profitability of a profit centre

112. Merck Pharmaceuticals is evaluating its Vioxx division, an investment centre. The division has a $45,000 controllable margin and $300,000 of sales. How much will Merck’s average operating assets be when its return on investment is 10%?

a) $450,000

b) $495,000

c) $300,000

d) $255,000

113. SuitCity purchased an operating asset expected to benefit the company for 10 years for a cost of $100,000 cash. The old operating asset was fully depreciated and was kept in operations. What effect will acquiring this asset have on the performance measurement of an investment centre?

a) a negative effect

b) a positive effect

c) No effect since cash replaces the asset sold.

d) More information is needed to determine the effect.

114. What effect does an increase in plant assets have on ROI?

a) an increase in controllable margin which increases ROI

b) a reduction of ROI

c) an increase in ROI

d) Unable to determine without the dollar amount of controllable margin known.

115. Which one of the following valuations of operating assets is NOT readily available from the accounting records?

a) cost

b) book value

c) market value

d) both cost and market value

116. Which one of the following is a distinguishing characteristic of an investment centre?

a) It includes significant uncontrollable fixed costs.

b) Performance can be evaluated using both profitability and return on utilizing assets.

c) This type of responsibility centre only generates revenues.

d) Revenues are rarely generated by selling products.

117. Which one of the following measures is frequently used to evaluate the performance of the manager of an investment centre, but NOT profit centres?

a) the amount of profit generated

b) the percentage increase in profit over the previous year

c) controllable margin

d) the rate of return on funds invested in the centre

118. What is included in operating assets for purposes of calculating ROI?

a) all assets that appear on a segment’s balance sheet

b) all depreciable assets

c) all current assets plus plant assets used in operations

d) all assets that are invested in stocks and bonds

119. Which one of the following will increase the return on investment?

a) When variable costs are increased.

b) When sales are increased.

c) When average operating assets are increased.

d) When fixed costs are increased.

120. An investment centre generated a contribution margin of $200,000, controllable fixed costs of $100,000 and sales of $1,000,000. The centre’s average operating assets were $400,000. How much is the return on investment?

a) 25%

b) 175%

c) 50%

d) 75%

121. How can the manager of an investment centre improve ROI?

a) by decreasing average operating assets

b) by increasing controllable fixed costs

c) by decreasing contribution margin

d) by increasing variable costs

122. Behavioural principles are often included in performance evaluation. What does this mean?

a) The human factor should be considered when evaluating performance.

b) Top management should evaluate lower managers.

c) The evaluation process must allow managers to respond to their evaluation.

d) Evaluation should identify only poor performance.

123. EKPN Company recorded the following operating data:

Sales $1,250,000

Contribution margin 485,000

Total direct fixed costs 400,300

Total operating assets Jan. 1, 2022 750,000

Total operating assets Dec. 31, 2022 790,000

EKPN Company’s desired return 12%

What is EKPN Company’s average operating assets for 2022?

a) $770,000

b) $750,000

c) $790,000

d) $150,000

124. EKPN Company recorded the following operating data:

Sales $1,250,000

Contribution margin 485,000

Total direct fixed costs 400,300

Total operating assets Jan. 1, 2022 750,000

Total operating assets Dec. 31, 2022 790,000

EKPN Company’s desired return 12%

What is EKPN Company’s ROI, rounded to the nearest whole number?

a) 11%

b) 12%

c) 53%

d) 55%

125. Beach Road Foods calculated the following ROIs for two potential investments. Beach Road’s required rate of return is 10%.

Investment A 11.5%

Investment B 9.5%

Which of the following should Beach Road choose?

a) Investment A

b) Investment B

c) Both, since both investments generate a positive return.

d) It depends on which investment generates the larger profit.

126. Frame, Inc. requires a return for the Picture Division totalling 8%. Which projects would either add value to or retain value for the company?

Project Average Operating Assets Controllable Margin

A $500,000 $40,000

B $450,000 $30,000

C $375,000 $32,000

D $425,000 $40,000

a) A, B, C, and D

b) Projects A, C, and D

c) Projects C and D

d) Project A, B, and D

127. The current controllable margin for Claremont Division is $62,000. Its current operating assets are $200,000. The division is considering purchasing equipment at the beginning of the year for $60,000 that will increase annual controllable margin by an estimated $10,000. If the equipment is purchased, what will happen to the return on investment for Claremont Division?

a) an increase of 16.1%

b) a decrease of 13.3%

c) a decrease of 3.3%

d) a decrease of 7.2%

128. CinRich Corporation recorded operating data for its Waterhole division for the year. CinRich requires its return to be 9%.

Sales $500,000

Controllable margin 90,000

Total average assets 300,000

Fixed costs 30,000

Residual income 50,000

How much is ROI for the year?

a) 10%

b) 16.7%

c) 20%

d) 30%

129. CinRich Corporation recorded operating data for its Waterhole division for the year. CinRich requires a 9% rate of return.

Sales $500,000

Controllable margin 90,000

Total average assets 300,000

Fixed costs 30,000

Residual income 50,000

Suppose CinRich experiences an increase of $50,000 in controllable fixed costs. Will the new ROI be acceptable?

a) Yes. The ROI will remain at 30% which exceeds the required ROI.

b) Yes. The new ROI is still above the required ROI.

c) No. The ROI drops to less than 9%.

d) There is not enough information to determine the new ROI.

130. How can management improve the return on investment?

a) by buying more plant assets

b) by reducing inventory levels

c) by reducing sales

d) by increasing expenses

131. Which statement is true?

a) An investment centre is responsible for revenues and expenses as well as earning a return on assets.

b) An investment centre is only responsible for its investments.

c) An investment centre is only responsible for revenues and expenses.

d) A profit centre is evaluated using residual income, while an investment centre is evaluated using ROI.

132. Fleur de Lys Segment of Windy’s restaurants is an investment centre. The manager is considering two possible expansion alternatives. The required investments, controllable margins, and the ROIs of each expansion project are as follows:

Project Investment Controllable Margin ROI

Power $ 75,000 $15,000 20%

Super 330,000 56,100 17%

The investment centre is currently generating an ROI of 15% based on $700,000 in operating assets and a controllable margin of $105,000. Which one of following projects will increase Fleur de Lys Segment’s ROI?

a) both Power and Super

b) only Power

c) only Super

d) neither Super nor Power

133. The following information was extracted from the accounting records of the City of Charlottetown, PEI:

Average assets increased by $100,000

Variable costs increased by $50,000

How much is the current year’s return on investment?

a) less than the prior year’s due to the change in variable costs

b) less than the prior year’s due to the change in average assets

c) no change between years

d) less than the prior year’s due to both the change in assets and variable costs

134. Jasper Recording Studio has a current return on investment of 10% and the company has established an 8% minimum rate of return for the division. The division manager has two investment projects available, for which the following estimates have been made:

Project A – annual controllable margin = $24,000, operating assets = $400,000

Project B – annual controllable margin = $60,000, operating assets = $550,000

Which project should be funded?

a) both projects

b) Project A

c) Project B

d) neither project

135. Lou Alabassi is the Northwest Territories Division manager and his performance is evaluated by executive management based on Division ROI. The current controllable margin for Northwest Territories Division is $46,000. Its current operating assets total $210,000. The division is considering purchasing equipment for $40,000 at the beginning of the year that will increase sales by an estimated $10,000, with annual depreciation of $10,000. If the equipment is purchased, what will happen to the return on investment for the division?

a) an increase of 0.5%

b) a decrease of 0.5%

c) a decrease of 3.5%

d) It will remain unchanged.

136. Cruise Division of Harrah’s Company’s operating results include: controllable margin, $150,000; sales, $1,750,000; and operating assets, $750,000. The Cruise Division’s ROI is 20%. Management is considering a project with sales of $125,000, variable expenses of $75,000, controllable fixed costs of $50,000; and an asset investment of $90,000. Should management accept this new project?

a) No, since ROI will be lowered.

b) Yes, since ROI will increase.

c) Yes, since additional sales always mean more customers.

d) No, since a loss will be incurred.

137. Managers who are evaluated on return on investment

a) may tend to underestimate the level of investment required in their division.

b) may tend to overestimate the level of investment required in their division.

c) may tend to underestimate the value of new product lines.

d) may tend to overestimate the value of new product lines.

*138. When comparing performance tools such as Return on Investment and Residual Income,

a) ROI is superior to RI.

b) RI is superior to ROI.

c) blending ROI and RI will eliminate the weaknesses inherent in both methods.

d) management must be clear in recognizing that each method has strengths and weaknesses.

*139. Residual income

a) is the income that remains after subtracting controllable costs from controllable margin.

b) tells management what percentage return was generated by the particular division being evaluated.

c) generates a dollar amount that represents the increase in value to the company beyond the cost necessary to pay for the financing of assets.

d) is different to economic value added as it is a measure of the income created by the investment centre above the cost of invested assets.

*140. The following information is available for Aggie Auto Sales:

Average operating assets $750,000

Controllable margin 90,000

Contribution margin 175,000

Minimum rate of return 10%

How much is Aggie Auto’s residual income?

a) $125,000

b) $640,000

c) $15,000

d) $85,000

BRIEF EXERCISES

Brief Exercise 151

Explain the four items that a budgetary control reporting system does.

Solution 151

The budgetary control reporting system does the following:

1. Identifies the name of the budget report, such as the sales budget or the manufacturing

overhead budget.

2. States the frequency of the report, such as weekly or monthly.

3. Specifies the purpose of the report.

4. Indicates the primary recipient(s) of the report.

Brief Exercise 152

Flames Company produces men’s ties. The following budgeted and actual amounts are for 2022:

Prepare a performance report for Flames Company for the year.

Solution 152

FLAMES COMPANY

Manufacturing Performance Budget Report

For the Year Ending December 31, 2022

Budget Actual Differences

Direct materials $ 63,800 $ 65,000 $1,200 U

Direct labour 81,200 81,000 200 F

Fixed overhead 35,000 34,500 500 F

Total costs $180,000 $180,500 $ 500 U

Brief Exercise 153

Hastings Manufacturing Co.'s static budget at 6,000 units of production includes $42,000 for direct labour and $6,000 for materials. Total fixed costs are $24,000. How much would appear on Hastings’s flexible budget for 2022 if 9,000 units are produced and sold?

Solution 153

Brief Exercise 154

A flexible budget graph for the waxing department shows the following:

1. At zero direct labour hours, the total budgeted cost line intersects the vertical axis at $75,000.

2. At normal capacity of 80,000 direct labour hours, the line drawn from the total budgeted cost line intersects the vertical axis at $135,000.

Identify the total fixed costs and the variable costs per unit.

Solution 154

Fixed costs = $75,000

Variable costs = ($135,000 – $75,000) ÷ 80,000 = $0.75 per direct labour hour

Brief Exercise 155

Shirk Productions makes a single product. Expected manufacturing costs are as follows:

Determine the amount of manufacturing costs for a flexible budget level of 3,200 units per month.

Solution 155

3,200 x ($6.50 + $2.40 + $1.10) + ($12,600 + $3,500 + $2,200) = $50,300

Brief Exercise 156

Sekine Company uses flexible budgets. Items from the budget for March in which 2,000 units were produced and sold appear below:

Direct materials $18,000

Indirect materials - variable 2,000

Supervisor salaries 15,000

Depreciation on factory equipment 4,000

Direct labour 10,000

Property taxes on factory 1,000

If Sekine prepares a flexible budget at 3,000 units, how much will its total variable cost be?

Solution 156

Variable cost per unit: ($18,000 + $2,000 + $10,000) / 2,000 = $15 per unit

Variable cost at 3,000 units: $15 x 3,000 = $45,000

Brief Exercise 157

SugarTown’s manufacturing costs for August when production was 1,000 units appears below:

Direct material $12 per unit

Direct labour $6,500

Variable overhead 5,000

Factory depreciation 9,000

Factory supervisory salaries 7,800

Other fixed factory costs 2,500

How much is the flexible budget manufacturing cost amount for a month when 800 units are produced?

Solution 157

Direct material ($12 x 800) $9,600

Direct labour [($6,500 / 1,000) x 800] 5,200

Variable overhead [($5,000 / 1,000) x 800] 4,000

Factory depreciation—fixed 9,000

Factory supervisory salaries—fixed 7,800

Other fixed factory costs—fixed 2,500

Total $38,100

Brief Exercise 158

Butterfly World budgeted sales for April were estimated at $500,000, sales commissions at 4% of sales, and the sales manager's salary at $80,000. The cost of shipping expenses was estimated at 1% of sales and miscellaneous selling expenses were estimated at $1,000 plus 0.5% of sales. How much are budgeted selling expenses on a flexible budget for April?

Solution 158

Sales commissions 4% x $500,000 $20,000

Sales manager’s salary 80,000

Shipping expenses 1% x $500,000 5,000

Miscellaneous selling: Fixed portion 1,000

Variable: 0.5% x $500,000 2,500

Budgeted selling expenses $108,500

Brief Exercise 159

Good Chicken Farms produces a single product, eggs. Expected manufacturing costs are as follows (in dozens):

Variable costs per dozen:

Direct materials $0.80

Direct labour 2.20

Production overhead 1.10

Fixed costs per month:

Management salaries $8,600

Depreciation 4,500

Other fixed costs 1,200

Determine the amount of manufacturing costs for a production level of 3,200 dozen per month.

Solution 159

[3,200 × ($0.80 + $2.20 + $1.10)] + ($8,600 + $4,500 + $1,200) = $27,420

Brief Exercise 160

Custom Air Corporation’s manufacturing costs for July when production was 500 units appears below:

Direct material $20 per unit

Factory depreciation $8,000

Variable overhead 4,000

Direct labour 1,500

Factory supervisory salaries 5,800

Other fixed factory costs 1,500

How much is the flexible budget manufacturing cost amount for a month when 550 units are produced?

Solution 160

Direct material ($20 x 550) $11,000

Direct labour [($1,500 / 500) x 550] 1,650

Variable overhead [$4,000 / 500 x 550] 4,400

Factory depreciation—fixed 8,000

Factory supervisory salaries—fixed 5,800

Other fixed factory costs—fixed 1,500

Total $32,350

Brief Exercise 161

New Clothing’s static budget at 2,000 units of production includes $10,000 for direct labour, $2,000 for utilities (variable), and total fixed costs of $16,000. Actual production and sales for the year was 6,000 units, with an actual cost of $52,400. Determine if New is over or under budget.

Solution 161

The company is over budget by $400. The flexible budget amount allowed was $52,000, and the company incurred $52,400.

Brief Exercise 162

Clark Inc. reported the following items for 2022:

Controllable fixed costs $ 56,000

Contribution margin 235,000

Interest expense 35,000

Variable costs 157,000

Total assets 1,690,000

How much is controllable margin?

Solution 162

$235,000 – $56,000 = $179,000

Brief Exercise 163

Back 2 Front Company makes products for the fashion industry. The head office is in Paris and it has branches in all the major cities in the world. All designs are made in the head office and sent to the branches where it is then the responsibility of the branch to manufacture the products and ship them to a warehouse. The products then get sent to stores whenever the sales department in Paris receives orders.

The company dictates that each branch complete an income statement with the following headings:

Sales to Customers

Direct materials

Indirect materials

Factory labour

Administration costs

Factory overhead

Head office allocated costs

Selling costs

Interest expense (allocated)

The Canadian branch has its offices in Vancouver.

Instructions

At an annual meeting to discuss results, determine which costs would be under the control of the Vancouver branch manager.

Solution 163

In a cost centre, the manager would only be responsible for those items directly under his or her control. In this example it would be direct and indirect materials, factory labour, administration costs, and factory overhead. All selling, interest expense, and any allocated head office costs would not be considered as being under the control of the manager.

Brief Exercise 164

Back 2 Front Company makes products for the fashion industry. The head office is in Paris and it has branches in all the major cities in the world. All designs are made in the head office and sent to the branches where it is then the responsibility of the branch to manufacture the products and ship them to a warehouse. The products then get sent to stores whenever the sales department in Paris receives orders.

The company dictates that each branch complete an income statement with the following headings:

Sales to Customers

Direct materials

Indirect materials

Factory labour

Administration costs

Factory overhead

Head office allocated costs

Selling costs

Interest expense (allocated)

The Canadian branch has its offices in Vancouver.

Back 2 Front Company is considering having each of its branches operate as a profit centre. It will still allocate only certain head office costs to the branches, but all products will be designed in the branches.

Instructions

If the changes are made to how the company operates, determine which costs would be under the control of the Vancouver branch manager as a result.

Solution 164

The Vancouver branch manager would be responsible for all costs except for the allocated head office charges and the interest expense, if these costs are still allocated from Paris. It is likely that the Vancouver manager would now be responsible for any new capital investment decisions as well as the interest cost associated with running the branch.

Brief Exercise 165

Explain the two ways in which the inputs to ROI can be measured.

Solution 165

1. Valuation of operating assets. Operating asset measures include acquisition cost,

book value, appraised value, or market value. The first two values are easily found in the

accounting records. Each of the alternative values for operating assets can be a reliable basis for evaluating a manager’s performance, as long as it is consistently used between reporting periods.

2. Margin (income) measure. Possible income measures may include the controllable margin, income from operations, or net income.

Brief Exercise 166

Data for the Electric Division of Bowden Baseball Company, which is operated as an investment centre follows:

Sales $2,750,000

Contribution Margin 900,000

Controllable Fixed Costs 400,000

Return on Investment 10%

Calculate controllable margin and average operating assets.

Solution 166

Controllable Margin ($900,000 – $400,000) = $500,000

Average Operating Assets ($500,000 ÷.10) = $5,000,000

Brief Exercise 167

The data for an investment centre is given below:

January 1, 2022 December 31, 2022

Current Assets $ 700,000 $ 900,000

Plant Assets 2,500,000 2,700,000

The controllable margin is $680,000. How much is the return on investment for the centre for 2022?

Solution 167

Average current assets ($700,000 + $900,000) ÷ 2 = $800,000

Average plant assets ($2,500,000 + $2,700,000) ÷ 2 = $2,600,000

ROI = Controllable Margin ÷ Average Operating Assets

= $680,000 ÷ ($800,000 + $2,600,000) = 20%

Brief Exercise 168

Wimmer Division’s operating results include:

• Controllable margin, $150,000
• Sales revenue, $1,200,000
• Operating assets, $500,000

Wimmer is considering a project with sales of $120,000, expenses of $84,000, and an investment of $180,000. Wimmer’s required rate of return is 15%. Should Wimmer accept this project considering the change to ROI that will occur?

Solution 168

Current ROI = $150,000 / $500,000 = 30%

ROI of new project = $36,000 / $180,000 = 20%

New ROI with project = [$150,000 + $36,000] / [$500,000 + $180,000] = 27.4%

While ROI decreases that does not make this a bad investment, since many projects cause total ROI to fall even though they increase the value of the division. The determination is based on how the ROI of the project compares to the required rate of return. The company is not willing to accept any projects with a rate of return of less than 15%, so the 20% project should be accepted.

Brief Exercise 169

EKPN Company is currently generating an ROI of 10%. The Winnipeg division of EKPN is operating as an investment centre. It is currently generating an ROI of 13% based on $130,000 in operating assets and a controllable margin of $16,900. The manager of the Winnipeg division has an opportunity to invest in an asset that will cost $30,000 and generate a controllable margin of $3,600.

Instructions

a) Would it be in the Winnipeg manager’s best interest to make the investment?

b) Would it be in EKPN’s best interest to make the investment?

Solution 169

a) The ROI on the investment is $3,600 / $30,000, or 12%. Since that is less than the Winnipeg’s current ROI of 13%, it would lower the ROI. The investment is not attractive for the Winnipeg division. New ROI = ($16,900 + $3,600) / ($130,000 + $30,000) or 12.8%.

b) The ROI on the investment of 12% is above EKPN’s current ROI of 10%; therefore, it would raise the company’s ROI. Accordingly, the investment is attractive for EKPN.

*Brief Exercise 170

The owner of Shrek Toys has recently expanded his business in order to add an additional product line. In addition to toys, the company will now sell shirts. The company has a minimum rate of return of 11%.

Toys Shirts

Sales $540,000 $326,000

Controllable margin 390,000 15,000

Average operating assets 750,000 300,000

Calculate the residual income for both investment centres.

*Solution 170

Toys Shirts

Controllable margin $390,000 $15,000

Average assets × 11% 82,500 33,000

Residual income $307,500 $(18,000)

*Brief Exercise 171

A & B Flooring has four divisions. Its hardwood flooring division’s information is as follows for 2022:

Sales $4,000,000

Controllable margin 250,000

Variable costs 60,000

Average operating assets 1,800,000

A & B’s required rate of return is 9%. How much is residual income?

*Solution 171

$250,000 – [9% x $1,800,000] = $88,000

*Brief Exercise 172

EKPN Company’s required rate of return is 10%. The Winnipeg division of EKPN is operating as an investment centre. It is currently generating an ROI of 13% based on $130,000 in operating assets and a controllable margin of $16,900. The manager of the Winnipeg division has an opportunity to invest in an asset that will cost $30,000 and generate a controllable margin of $3,600. Is the investment opportunity attractive to the Winnipeg division if the division is evaluated based on residual income?

*Solution 172

Current residual income: $16,900 – ($130,000 x 10%) = $3,900

Residual income after investment: $16,900 + $3,600 – ([$130,000 + $30,000] x 10%) = $4,500

The investment is attractive to the Winnipeg division, since it will increase its residual income.

*Brief Exercise 173

An investment centre of Anora Company has an operating profit after tax of $110,000, a weighted average cost of capital of 6% and total capital used of $1,200,000.

Instructions

Has the company added economic value or lost capital and by how much?

*Solution 173

Given that the EVA is positive at $38,000 [$110,000 – (.06 x $1,200,000)], the company has added economic value.

Exercises

Exercise 174

Robinson Company expects to produce 7,500 units of the product ABC for the month of August 2022. Budgeted variable manufacturing costs per unit are direct materials $9, direct labour $15, and overhead $25.

Monthly budgeted fixed manufacturing overhead costs are $15,000 for depreciation and $7,500 for supervision. In the current month, Robinson produced 8,250 units and incurred the following costs: direct materials $50,850, direct labour $111,300, variable overhead $180,750, depreciation $15,000, and supervision $7,500.

Instructions

Prepare a static budget report. (Hint: The Budget column is based on estimated production of

7,500 units while the Actual column is the actual costs incurred during the period. Determine if there is a Favourable or Unfavourable variance.)

Solution 174 (10 min.)

ROBINSON COMPANY

Static Budget Report

For the Month Ended August 31, 2022

Budget Actual Difference

Units produced 7,500 8,250 F= Favourable

UF = Unfavourable

Variable costs

Direct materials ($9) $67,500 $50,850 $16,650 F

Direct labour ($15.00) 112,500 111,300 1,200 F

Overhead ($25) 187,500 180,750 6,750 F

Total variable costs 367,500 342,900 24,600 F

Fixed costs

Depreciation $15,000 15,000 0

Supervision 7,500 7,500 0

Total fixed costs 22,500 22,500 0

Total costs $412,500 387,900 $24,600 F

Exercise 175

Cheatem Trading Company's master budget reflects budgeted sales information for the month of March, 2022, as follows:

Budgeted Quantity Budgeted Unit Sales Price

Baking potatoes 35,000 kilograms $0.75 per kilogram

Boiling potatoes 20,000 kilograms $0.30 per kilogram

During March, the company actually sold 37,000 kilograms of baking potatoes at an average price of $0.73 per kilogram and 17,000 kilograms of boiling potatoes at an average price of $0.32 per kilogram.

Instructions

Prepare a Sales Budget Report for the month of March for Cheatem Trading Company, which shows whether the company achieved its planned objectives.

Solution 175 (6–8 min.)

CHEATEM TRADING COMPANY

Sales Budget Report

For the Month Ended March 31, 2022

Product Line Budget Actual Difference

Baking Potatoes $26,250 $27,010 $760 F

Boiling potatoes 6,000 5,440 560 U

Total sales $32,250 $32,450 $200 F

Exercise 176

Cranium Co.'s static budget at 5,000 units of production includes $60,000 for direct labour and $35,000 for materials. Total fixed costs are $12,000.

Instructions

a) Determine how much would appear on Cranium’s flexible budget for 2022 if 6,000 units are produced and sold.

b) How would this comparison differ if a static budget were used instead of a flexible budget for performance evaluation?

Solution 176 (7–9 min.)

a) 5,000 Units Unit Variable Cost 6,000 Units

Variable costs:

Direct labour $60,000 $12 $72,000

Direct materials 35,000 7 42,000

95,000 114,000

Fixed costs 12,000 12,000

Total costs $107,000 $126,000

b) If a static budget were used, budgeted variable costs would be lower because they would be based on the static budget level of 5,000 units. The company would appear over budget since the costs incurred would be correlated to a higher level of activity.

Exercise 177

Toto Dog Toys developed its annual manufacturing overhead budget for its master budget for 2022 as follows:

Expected Annual Operating Capacity: 90,000 Direct Labour Hours

Variable overhead costs

Indirect labour $360,000

Indirect materials 27,000

Factory supplies 63,000

Total variable costs 450,000

Fixed overhead costs

Depreciation 72,000

Supervision 70,000

Property taxes 12,000

Total fixed costs 154,000

Total costs $604,000

The relevant range for monthly activity is expected to be between 80,000 and 100,000 direct labour hours.

Instructions

Prepare a flexible budget for a monthly activity level of 85,000 direct labour hours.

Solution 177 (8–10 min.)

TOTO DOG TOYS

Monthly Flexible Manufacturing Overhead Budget at 85,000 Direct Labour Hours

Variable overhead costs:

Indirect labour $340,000

Indirect materials 25,500

Factory supplies 59,500

Total variable costs $425,000

Fixed overhead costs:

Depreciation 72,000

Supervision 70,000

Property taxes 12,000

Total fixed costs 154,000

Total costs $579,000

Exercise 178

Jessica Simpson Music Company has prepared the following monthly flexible manufacturing overhead budget for its Lip Sync Department:

4,000 Units 5,000 Units

Indirect labour $32,000 $40,000

Indirect materials 44,000 55,000

Factory supplies 36,000 45,000

Depreciation 17,000 17,000

Supervision 5,500 5,500

Property taxes 1,250 1,250

Total costs $135,750 $163,750

Instructions

Prepare a flexible budget at 4,700 units of activity.

Solution 178 (8–10 min.)

JESSICA SIMPSON MUSIC COMPANY

Monthly Flexible Manufacturing Overhead Budget at 4,700 Units

Lip Sync Department

Variable overhead costs:

Indirect labour $ 37,600

Indirect materials 51,700

Factory supplies 42,300

Total variable costs $131,600

Fixed overhead costs:

Depreciation 17,000

Supervision 5,500

Property taxes 1,250

Total fixed costs 23,750

Total costs $155,350

Exercise 179

Usher Music Company uses a flexible budget for overhead based on studio hours. Variable overhead costs per studio hour are as follows:

Indirect Labour $ 4.25

Indirect Materials 1.27

Maintenance 0.34

Utilities 0.15

Fixed overhead costs per month are:

Supervision $900

Insurance 700

Property Taxes 400

Depreciation 600

The company believes it will normally operate in a range of 2,000 to 4,000 studio hours per month.

Instructions

Prepare a flexible manufacturing overhead budget for 2,500 studio hours.

Solution 179 (8–10 min.)

USHER MUSIC COMPANY

Monthly Flexible Manufacturing Overhead Budget at 2,500 Studio Hours

Variable overhead costs:

Indirect Labour $10,625

Indirect Materials 3,175

Maintenance 850

Utilities 375

Total variable costs $15,025

Fixed overhead costs:

Supervision 900

Insurance 700

Property Taxes 400

Depreciation 600

Total fixed costs 2,600

Total costs $17,625

Exercise 180

Outkast Company uses a flexible budget for manufacturing overhead based on machine hours. Variable manufacturing overhead costs per machine hour is as follows:

Indirect labour $0.50

Indirect materials 1.50

Maintenance .40

Utilities .20

Budgeted fixed overhead costs per month are:

Supervision $4,000

Insurance 2,000

Property taxes 1,000

Depreciation 9,000

The company believes it will normally operate in a range of 28,000 to 35,000 machine hours per month. During the month of August, 2022, the company incurred the following manufacturing overhead costs:

Indirect Labour $14,800

Indirect Materials 44,000

Maintenance 12,000

Utilities 6,500

Supervision 4,200

Insurance 2,100

Property Taxes 800

Depreciation 8,600

Instructions

Prepare a flexible budget report, assuming that the company used 31,000 machine hours during August.

Solution 180 (10–12 min.)

OUTKAST COMPANY

Manufacturing Overhead Budget Report (Flexible)

For the Month Ended August 31, 2022

Exercise 181

Eastwood Music uses flexible budgets to control its selling expenses. Monthly sales are expected to range from $400,000 to $450,000. Variable costs and the percentage relationships to sales are:

Sales commissions 8%

Advertising 5%

Travelling 15%

Delivery 2%

Fixed selling expenses consist of sales salaries of $50,000 and depreciation on stage and production equipment totalling $12,000.

Instructions

Prepare a flexible budget for $420,000 of sales.

Solution 181 (7–9 min.)

EASTWOOD MUSIC

Monthly Flexible Selling Expense Budget at $420,000 of Sales

Variable costs:

Sales commissions $ 33,600

Advertising 21,000

Travelling 63,000

Delivery 8,400

Total variable costs $126,000

Fixed costs:

Sales salaries 50,000

Depreciation 12,000

Total fixed costs 62,000

Total costs $188,000

Exercise 182

Westwood Music uses flexible budgets to control its selling expenses. Monthly sales are expected to range from $400,000 to $450,000. Variable costs and the percentage relationships to sales are:

Sales commissions 8%

Advertising 5%

Travelling 15%

Delivery 2%

Fixed selling expenses consist of sales salaries of $50,000 and depreciation on stage and production equipment totalling $12,000.

The actual selling expenses incurred in March, 2022, by Westwood Music are as follows:

Sales commissions $35,000

Advertising 19,800

Travelling 64,000

Delivery 8,200

Fixed selling expenses consist of sales salaries of $48,800 and depreciation on delivery equipment totalling $11,000.

Instructions

Prepare a flexible budget performance report, assuming that March sales were $420,000. Expected and actual sales are the same.

Solution 182 (10–12 min.)

WESTWOOD MUSIC

Selling Expense Budget Report (Flexible)

For the Month Ended March 31, 2022

Exercise 183

Sinclair Components uses flexible budgeting to control manufacturing overhead. The budget below was prepared for the month ending June 30, 2022:

During the month of June, the company used direct labour hours totalling 11,600 and the following costs were incurred:

Indirect materials $13,200

Indirect labour 16,200

Utilities 2,500

Rent 9,900

Depreciation 7,800

Insurance 5,200

Instructions

Prepare a flexible budget that could be used for performance evaluation of this company.

Solution 183 (8–9 min.)

SINCLAIR COMPONENTS

Flexible Budget at 11,600 Units

For the Month Ended June 30, 2022

Variable costs:

Indirect materials $13,920

Indirect labour 6,960

Utilities 2,784

Total variable costs 23,664

Fixed costs:

Rent 10,000

Depreciation 8,000

Insurance 5,500

Total fixed costs 23,500

Total costs $47,164

Exercise 184

Candle Light Bus Lines Ltd. runs a series of bus routes between cities across Canada. A new route, between Kenora and Thunder Bay, has been planned for next year. The sales manager has come up with a series of possible passengers that would use the route in the upcoming year.

She tells you that passengers could range between 20,000 and 40,000 per year and that each ticket would be $25 per trip. Because of the availability of buses to service the route, the estimated passengers would be in increments of 10,000.

The controller of the company provides you with the following information:

Costs per passenger per trip:

Fuel $5

Driver $4

Selling $2

Admin $1

In addition, she informs you that Facility Overhead will be $100,000 and Selling and Admin Overhead will be $50,000, regardless of the number of trips made in the year.

Instructions

a) Prepare a flexible budget for the company based on the above information for 20,000, 30,000, and 40,000 passengers.

b) Assume that there were actually 22,450 passengers who used the bus this year and sales totalled $538,800. Fuel costs were $123,475, driver costs were $95,415 and selling and admin variable costs were $41,500 and $17,250, respectively. Facility Costs were $125,000 and Selling and Admin Overhead was $78,000. Prepare a flexible budget report, including the budget variance, for the year.

c) Discuss the results of the year and what action should be taken in the future as a result.

Solution 184 (12–16 min.)

a)

Budgeted Cost Passenger Trips

Per Passenger 20,000 30,000 40,000

Sales $25 $500,000 $750,000 $1,000,000

Variable Costs:

Fuel 5 100,000 150,000 200,000

Driver 4 80,000 120,000 160,000

Selling 2 40,000 60,000 80,000

Admin 1 20,000 30,000 40,000

Contribution Margin $13 260,000 390,000 520,000

Fixed Costs:

Facility Costs 100,000 100,000 100,000

Selling & Admin 50,000 50,000 50,000

Operating Income $110,000 $240,000 $370,000

b)

Passenger Trips

Flexible

Budgeted Cost Flexible Budget

Per Passenger Actual Budget Variance

22,450 22,450 22,450

Sales $25 $538,800 $561,250 $22,450 U

Variable Costs

Fuel 5 123,475 112,250 11,225 U

Driver 4 95,415 89,800 5,615 U

Selling 2 41,500 44,900 3,400 F

Admin 1 17,250 22,450 5,200 F

Contribution Margin $13 261,160 291,850 30,690 U

Fixed Costs:

Facility Costs 125,000 100,000 25,000 U

Selling & Admin 78,000 50,000 28,000 U

Operating Income $58,160 $141,850 $83,690 U

c) The budget is showing unfavourable variances throughout most of the major items. First off, the manager must investigate why selling prices were reduced by $1 per trip per year. The large unfavourable variances for fuel and drivers must also be investigated, although fuel costs would likely have gone up due to general price increases, this should be confirmed.

The costs to operate the facility are up dramatically as are the fixed selling and admin overhead costs; perhaps there is an internal allocation from the accounting department that should be investigated.

Exercise 185

Ashley Sofa Store produces sofas. The following budgeted and actual amounts are for 2022:

Cost Budget at 7,000 units Actual Amounts at 7,500 units

Direct materials $63,000 $64,000

Direct labour 49,000 49,500

Equipment depreciation 10,000 10,000

Indirect labour 5,600 5,700

Indirect materials 14,000 14,900

Rent and insurance 15,000 15,100

Instructions

Prepare a performance report for Ashley Sofa Store for the year, comparing budgeted amounts to actual results and highlighting any favourable or unfavourable variances.

Solution 185 (6–8 min.)

ASHLEY SOFA STORE

Manufacturing Performance Budget Report

For the Year Ending December 31, 2022

Budget Actual Differences

Direct materials $67,500 $64,000 $3,500 F

Direct labour 52,500 49,500 3,000 F

Equipment depreciation 10,000 10,000 0

Indirect labour 6,000 5,700 300 F

Indirect materials 15,000 14,900 100 F

Rent and insurance 15,000 15,100 100 U

Total costs $166,000 $159,200 $6,800 F

Exercise 186

Data concerning manufacturing overhead for Wilson Audio are presented below. The packaging department is a cost centre.

An analysis of the overhead costs reveals that all variable costs are controllable by the manager of the packaging department, and only 40% of fixed supervisory costs are controllable at the department level. The flexible budget values and the cost, including activity for the month of August at an operating level of 1,600 direct labour hours are presented as follows:

Flexible Budget Actual August Activity

Variable costs:

Indirect materials $2.00 $ 3,000

Indirect labour 3.00 4,500

Factory supplies 0.50 750

Fixed (including controllable and non-controllable) costs:

Depreciation $14,000 15,000

Supervision 20,000 19,000

Property taxes 14,000 12,000

Total costs $56,800 $54,250

Instructions

a) Prepare the responsibility reports for the packaging department for August comparing budgeted amounts to actual results and highlighting any favourable or unfavourable variances.

b) Comment on the manager's performance in controlling costs during the month.

Solution 186 (9–12 min.)

a)

WILSON AUDIO PACKAGING DEPARTMENT

Manufacturing Overhead Cost Responsibility Report at 1,600 Direct Labour Hours

For the Month of August

b) The manager did a good job of controlling costs in August. All of the costs were under budget and none look materially out of line.

Exercise 187

Ozzie Osborne Manufacturing Company’s overhead budget for the first quarter of 2022 contained the following data:

Variable Costs

Indirect Materials $12,000

Indirect Labour 4,000

Utilities 3,000

Maintenance 5,000

Fixed Costs

Supervisor's Salary $21,000

Depreciation 5,000

Property taxes 3,000

Actual variable costs for the first quarter were:

Indirect Materials $13,300

Indirect Labour 4,200

Utilities 3,050

Maintenance 5,600

Actual fixed costs were as expected except for property taxes, which were $3,100. All costs are considered controllable by the department manager except for the supervisor's salary. The company manufactured and sold 1,100 units; however, its budget was based on 1,000 units.

Instructions

Prepare a manufacturing overhead responsibility performance report for the first quarter comparing budgeted amounts to actual results and highlighting an favourable or unfavourable variances.

Solution 187 (8–9 min.)

OZZIE OZBORNE MANUFACTURING COMPANY

Manufacturing Overhead Cost Responsibility Report at 1,100 Units

For the Quarter Ended March 31, 2022

Controllable Costs Budget Actual Difference

Indirect materials $13,200 $13,300 $100 U

Indirect labour 4,400 4,200 200 F

Utilities 3,300 3,050 250 F

Maintenance 5,500 5,600 100 U

Depreciation 5,000 5,000 —

Property taxes 3,000 3,100 100 U

Total costs $34,400 $34,250 $150 F

Exercise 188

Compare and contrast centralized and decentralized decision-making. Why would any firm decentralize its operations?

Solution 188 (4–5 min.)

Decentralization is the delegation of decision-making authority to lower levels of management. In centralized decision-making, decisions are made at the top levels of management. Lower level management is responsible for implementing such decisions, which have been forced on them. By contrast, in decentralized decision-making, decisions are both made and implemented by various levels of management.

Various reasons for decentralizing include: access to relevant, local information at all levels of the organization, more timely response times, ability of central management to focus attention on corporate level decision making, training and evaluation, motivation, and enhanced competition among sub-units.

Exercise 189

Identify the three conditions under which responsibility accounting can be used at every

level of management.

Solution 189 (7–9 min.)

Responsibility accounting can be used at every level of management where the following conditions exist:

1. Costs and revenues can be directly associated with the specific level of management

responsibility.

2. The costs and revenues are controllable at the level of responsibility that they are

associated with.

3. Budget data can be developed for evaluating the manager’s effectiveness in controlling

the costs and revenues.

Exercise 190

Maritime Division, a profit centre of Hurricane Weather Company, reported the following data for the first quarter of 2022:

Sales $2,000,000

Variable costs 1,200,000

Controllable direct fixed costs 200,000

Non-controllable direct fixed costs 150,000

Controllable indirect fixed costs 40,000

Instructions

a) Prepare a performance report for the manager of the Maritime Division.

b) How would the responsibility report differ if the division was an investment centre?

Solution 190 (5–6 min.)

a)

MARITIME DIVISION OF HURRICANE WEATHER COMPANY

Management Performance Report

For the Quarter Ended March 31, 2022

Sales $2,000,000

Variable costs 1,200,000

Contribution margin 800,000

Controllable fixed costs 240,000

Controllable margin $ 560,000

b) For an investment centre, the responsibility report would also show the return on investment for the period.

Exercise 191

Myrna’s Market has two divisions: fruits and vegetables. The fruits division had sales of $500,000 and a contribution margin ratio of 15%. The vegetables division had a contribution margin of $50,000 and variable costs of $300,000. Controllable fixed costs in total were $70,000, with the fruits division having 60% of the total. Myrna’s Market’s net income was $20,000.

Instructions

a) Prepare an income statement for Myrna’s Market in total and for its two divisions.

b) Based on ROI, which division is performing better? Assume the fruits division has $220,000 in operating assets and the vegetables division has $275,000 in operating assets.

Solution 191 (6–8 min.)

a)

MYRNA’S MARKET

Income Statement

For the Period Ending...

Company Fruits Vegetables

Sales $850,000g $500,000 $350,000h

Variable Costs 725,000f 425,000e 300,000

Contribution Margin 125,000b 75000a 50,000

Controllable Fixed Costs 70,000 42,000i 28,000j

Controllable Margin 55,000c $33,000 $22,000

Other Fixed Costs 35,000d

Net Income $20,000

Italic numbers given:

a $500,000 x 15%

b 75,000 + 50,000

c 125,000 – 70,000

d 55,000 – 20,000

e 500,000 – 75,000

f 425,000 + 300,000

g 725,000 + 125,000

h 850,000 – 500,000 or 300,000 + 50,000

I 70,000 x 60%

j 70,000 x 40%

b)

ROI Fruits Division = $33,000 / $220,000 = 15%

ROI Vegetable Division = $22,000 / $120,000 = 18.3%

Exercise 192

The Candle Division of Dax Wax Company reported the following results for 2022:

Sales $800,000

Variable costs 420,000

Controllable fixed costs 100,000

Average operating assets 4,000,000

Management is considering the following independent alternative courses of action in 2021 in order to maximize the return on investment for the division.

1. Reduce controllable fixed costs by 50% with no change in sales or variable costs.

2. Reduce average operating assets by 30% with no change in controllable margin.

3. Increase sales $200,000 with no change in the contribution margin percentage.

Instructions

a) Calculate the return on investment for 2022.

b) Calculate the expected return on investment for each of the alternative courses of action.

Solution 192 (6–8 min.)

a) Controllable margin

Return on investment = ————————————

Average operating assets

$280,000

2022 ROI = ————–— = 7%

$4,000,000

*$380,000 / $800,000 = 47.5% contribution margin

Exercise 193

Dromedrille Company has the following results for the year just ended:

Sales $2,000,000

Operating Income $125,000

Capital Investment $600,000

What is the company’s Return on Investment for the year?

Solution 193 (4–6 min.)

2,000,000 ÷ 600,000 x 125,000 ÷ 2,000,000 = 20.8%

*Exercise 194

Complete the missing information in the columns below:

*Solution 194 (12–16 min.)

(a) $100,000 – $30,000 + $20,000 = $50,000

(b) $30,000 / 10% = $300,000

(c) $30,000 – (8% x $300,000) = $6000

(d) $100,00 + $25,000 + $45,000 = $170,000

(e) $100,000 – 10% x Operating Assets = $2000; Operating Assets = $98,000 / 10% = $980,000

(f) $100,000 / $980,000 = 10.2%

(g) $450,000 – $115,000 – $155,000 = $180,000

(h) Controllable Margin – 12% x 1,000,000 = $(5000); Controllable Margin = $120,000 + $5000 = $115,000

(i) $115,000 / $1,000,000 = 11.5%

*Exercise 195

Dromedrille Company has the following results for the year just ended:

Sales $2,000,000

Operating Income $125,000

Capital Investment $600,000

Required Rate of Return 6%

What is the company’s Residual Income for the year?

*Solution 195 (4–6 min.)

$125,000 – (6% x $600,000) = $89,000

COMPLETION STATEMENTS

196. The ___ budget is also called a static budget.

197. A major aspect of budgeting control is the use of budget reports that compare actual results with ___.

198. In analyzing variances using a management by exception approach, only variances that are ___ and ___ are reviewed.

199. The master budget is a ___ budget, which is based on operating at one budgeted activity level.

200. A ___ budget projects budget data for various levels of activity.

201. Total ___ costs will be the same on the master budget and on a flexible budget, which reflects the actual level of activity.

202. Under ___ accounting, the evaluation of a manager's performance is based on the costs and revenues directly under that manager's control.

203. A cost is ___ at a given level of managerial responsibility if a manager has the authority to incur the cost in a given time period.

204. In general, costs that are incurred for the benefit of more than one division are considered ___.

205. Responsibility centres may be classified into three types: (1)___, (2)___ and, (3)___.

206. The primary basis for evaluating the performance of a manager of an investment centre is ___.

207. Return on investment is calculated by dividing ___ by ___.

*208. Residual income is the income that remains after subtracting from the ___, the minimum rate of return on a company’s average operating assets.

ANSWERS TO COMPLETION STATEMENTS

196. master

197. planned objectives

198. material, controllable

199. static

200. flexible

201. fixed

202. responsibility

203. controllable

204. non-controllable

205. cost centres, profit centres, investment centres

206. return on investment (ROI)

207. controllable margin, average operating assets

*208. controllable margin

MATCHING

209. Match the items below by entering the appropriate code letter in the space provided.

A. Budgetary control G. Responsibility reporting system

B. Static budget H. Return on Investment

C. Flexible budget I. Profit centre

D. Responsibility accounting J. Investment centre

E. Controllable costs K. Indirect fixed costs

F. Management by exception L. Direct fixed costs

___ 1. A projection of budget data for various levels of activity.

___ 2. A responsibility centre that incurs costs, generates revenues and has control over the investment funds available for use.

___ 3. Costs that relate specifically to a responsibility centre and are incurred for the sole benefit of the centre.

___ 4. A responsibility centre that incurs costs and generates revenues.

___ 5. Costs that are incurred for the benefit of more than one profit centre.

___ 6. A measure of the profitability of an investment centre calculated by dividing controllable margin (in dollars) by average operating assets.

___ 7. The review of budget reports by top management directed entirely, or primarily, to differences between actual results and planned objectives.

___ 8. A part of management accounting that involves accumulating and reporting revenues and costs on the basis of the individual manager, who has the authority to make the day-to-day decisions about the items.

___ 9. The preparation of reports for each level of responsibility shown in the company's organizational chart.

___ 10. A projection of budget data at one level of activity.

___ 11. Costs that a manager has the authority to incur within a given period.

___ 12. The use of budgets to control operations.

ANSWERS TO MATCHING

1. C

2. J

3. L

4. I

5. K

6. H

7. F

8. D

9. G

10. B

11. E

12. A

SHORT-ANSWER ESSAY QUESTIONS

SAE 210

Clara County Electronics manufactures circuit boards for computer-controlled appliances for home use. The sales have been very volatile, sometimes stressing the plant's capacity, and sometimes depressingly slow. During a recent slow period, Earl Linton, a production supervisor, complained to Ann Royer, accounting manager, about the flexible budget.

"I try as hard as I can to meet the budget," he says, "and then I find out that just meeting the budget's not good enough. Last month, when we sold 8,000 units, I was $10,000 under my budget, and then you all blow me out of the water with your report saying that I was $5,000 over, because sales were slow. I thought this responsibility accounting business was supposed to mean we are held accountable just for things we can control. How do we control sales? At the beginning of the year, you gave us all targets. Mine says that for an average month of 10,000 units in sales, I should spend about $82,000. I spent less and still received an unfavourable budget report. How is this possible?"

Instructions

Write a short memo to respond to Mr. Linton.

Solution 210

TO: Earl Linton

FROM: Ann Royer

RE: Budget results

I appreciate your coming to me with your questions regarding the budget. I understand that the new procedures can be frustrating, especially when you receive an unfavourable report that you were not expecting.

A flexible budget does mean that you are held accountable only for the costs that you can control. Last month, we calculated the cost of producing 8,000 units that were sold (and not the 10,000 that were estimated to be sold). Your costs were greater than what should have been incurred for a sales level of 8,000 units, although still less than the amount you would have been allowed to spend had the full 10,000 units been sold. Please check the individual items on your budget report. We noted which ones exceeded the budget. You can then focus attention on those items for cost control.

Please contact the Accounting Department if you have further questions.

SAE 211

How does the system of responsibility reporting work? What occurs at each level? Is management by exception possible in a responsibility reporting system? Explain.

Solution 211

The system of responsibility reporting begins with the lowest level of responsibility and moves up through each level. At the lowest level, each manager receives detailed information concerning the controllable costs for which they are responsible. At higher levels of responsibility, the detail of the lower levels may be omitted but the report encompasses all the areas for which the higher level has responsibility. For example, a plant manager will receive reports concerning the controllable costs of each of the plant departments.

Management by exception is possible in such a system because, if management at the higher levels of responsibility identifies a significant variance, they can receive detailed reports for each lower level of responsibility. This allows management to investigate causes and remedies for variances as they feel necessary.

SAE 212

Managers are motivated to accomplish objectives if they believe that their efforts will be fairly evaluated. Explain why an organization may use different bases for evaluating the performance of managers of different types of responsibility centres.

Solution 212

Because a manager should only be evaluated based on the performance results of matters that are controllable by the manager, it is necessary to use different bases for evaluation. An investment centre manager can control the investment funds available as well as costs and revenues. Return on investment is therefore an appropriate basis for evaluation. A profit centre, however, controls only revenues and expenses but not investment, so controllable margin is a more appropriate basis relating only to the areas controllable by the profit centre. Similarly, because only costs are controllable for a cost centre, such a centre is evaluated only on the basis of its controllable costs.

SAE 213

Edwards Corporation evaluates its managers based on return on investment (ROI). Kim Tilley and Sara Trane, managers of the electronics and housewares departments respectively, have recently suffered from declining profits in their departments. Over lunch, they discuss the problem, and how they could improve performance. Most of the discussion centres around ways to increase sales. Near the end of the lunch period, however, Sara remarks that there are two components to consider, and that they have considered only one. She wonders whether there is some way to reduce investment, and by decreasing the denominator of the ROI fraction, to improve the overall result.

Back at work, Kim continues to mull over Sara's remarks. She decides to pursue the matter further, and before the end of the quarter she has sold quite a bit of older equipment and replaced it with equipment obtained with a short-term lease. Her performance, measured by ROI, is markedly improved, although sales continue to be disappointing.

Instructions

a) Who are the stakeholders in this situation?

b) Are Kim's actions ethical? Briefly explain.

Solution 213

a) The stakeholders include

Kim Tilley

Sara Trane

managers of Edwards Corporation

shareholders of Edwards Corporation

b) Kim's actions may not be ethical. It appears that she has replaced equipment that had been purchased only because such a move would improve her ROI. Of course, it is possible that the leased equipment will allow her department to function better, resulting in a benefit for the company. However, any action to promote one's own benefit at the expense of the company's welfare is unethical.

*SAE 214

Explain how the economic value added (EVA) approach differs from the residual income approach.

*Solution 214

The EVA approach differs from the residual income approach in two ways. First,

EVA uses the weighted-average cost of capital instead of the minimum rate of return on the

invested assets. Second, EVA calculates an investment centre’s profit after tax. Basically, the

EVA is calculated by deducting the total cost of capital (equity and borrowing) from the net

income after tax.

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