Chapter 14 Cases & Readings

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Chapter 14 Cases Readings

• Presented by Team 4
• Chakraborty, Madhuri
• Nambiar, Jisha
• Rajendrakumar, Jinashree
• Singh, Shalini
• Tyagi, Priyanka

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Case 14-1Berkshire Toy Company
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The Hierarchy
4
The milestones ..

• Berkshire Toy Company was founded by Franklin
  Berkshire, Janet McKinley's father, in 1974
• By 1986 ,the annual sales exceeded a million
  dollar .
• In 1991, the company launched an initial public
  offering and became a publicly traded co. on
  NASDAQ.
• In 1993 , Janet McKinley became the CEO of the
  company
• In 1995 , Berkshire was acquired by Quality
  product corporations

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The Product

• Berkshire Bear, a fifteen inch teddy bear
• The co. Advertises its product as the only teddy
  bear made in America .
• The bears were fully jointed, constructed of
  washable acrylic pile fabric and stuffed with
  polyester filing.
• The toys are dressed in various accessories.
• Berkshire bear is sold with an unconditional
  lifetime warranty.

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Production process ..

• Cutting ? Sewing ?Filling ?Assembly

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Marketing ..

• Retail internet sales is a new addition to the
  overall marketing effort.
• Company also sells to department stores, toy
  boutiques and other specialty stores.
• The Berkshire bear is sold in designer boxes
  ,which contributes to the image of the product.
• Commission of 3 is paid on retail stores sales
  and the sales to the wholesale buyers
• No commission is paid on catalog sales

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The Bonus Plan ..

• David Hall , the purchasing manager receives a
  bonus equal to 20 of the net material price
  variance.
• Rita Smith, the marketing manager, will receive
  a bonus equal to 10 of the excess of actual net
  revenue over the master budget net revenue .
• Bill Wilford , the production manager , receives
  a bonus equal to 3 of the net of several
  variances.
• (the efficiency variance for material, labor,
  and variable overhead the labor rate variance
  and the variable and fixed overhead spending
  variance)

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Sales Details
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Table 1

• Berkshire Toy Company A Divisions of Quality
  Products Corporation
• Schedule
  showing flexible budget variance

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Table 1
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Table 1
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Sales Analysis
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Sales Analysis

• Master static budget Flexible Budget
  Flexible Budget
• MS F1 F2 budgeted
  mix actual sales mix
  budgeted mix

Sales Mix variance Effect on revenue due to
difference between the actual mix of distribution
and the budgeted mix
Sales Volume Variance Effect on revenue due to
selling more or fewer units than planned
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Direct Materials analysis
Data from Table 2 and Table 3
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DIRECT MATERIAL VARIANCES
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Direct Labor analysis
Data from Table 2 and Table 3
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DIRECT LABOR VARIANCES
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VARIABLE OVERHEAD VARIANCES
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1. b) Compute Bonuses earned
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Q2 a) Explain the variance

• Direct material price variance was favorable

• Reasons
• Substandard quality of material
• Price change of the material
• Changes in the freights costs

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Q2 a) Explain the variance contd..

• Direct Material Usage variance was unfavorable
• Reasons
• Variation in the quality of direct materials
• Inadequate training or inexperienced employees
• Excessive spoilage (thunderstorm )

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Q2 a) Explain the variance contd..

• Direct labor price variance was unfavorable
• Reasons
• Some workers had to be replaced at higher than
  standard wage rate.
• Skill set of the replaced workers could have been
  lesser then required leading to higher costs .

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Q2 a) Explain the variance contd..

• Direct labor efficiency/usage variance was
  unfavorable
• Reasons
• Machine /equipment was not in proper working
  condition
• The material was of substandard quality
• Deviation from standard production plans
• Plant was operating at near to maximum capacity,
  people were tired

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Q2 a) Explain the variance contd..

• Variable overhead spending variance was
  unfavorable
• Reasons
• Maintenance supplies expenses increased
• Frequent breakdowns
• Overtime premium expenses increased
• Variable overhead efficiency/usage variance was
  unfavorable
• Reasons
• Maintenance labor increased due to breakdown and
  extra maintenance required on machinery
• Overtime labor hours increased

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Q2 b) Advantages of incentive compensation plan

• Intended towards promoting participation and
  teamwork
• Incentive Plan discussed with department heads
• Department heads rewarded based on individual
  responsibility center
• Rewarded managers fairly for individual
  contributions and achievements
• Brought groups of employees to work together
  toward a common goal (the bottom line of the
  company).
• In this case the manager and not the department
  was getting the incentive !!!!
• Motivation for individuals to perform
• Purchasing manager was motivated to look for
  discounts

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Disadvantages of the incentive compensation plan

• Marketing myopic focus on revenues.
• Rita increased the sales volume but used less
  profitable distribution mix.
• Sales mix variance shows that the actual mix of
  channels was less profitable than the budgeted
  mix of 85( retail and catalog) and 15
  (wholesale)
• Production
• Penalized for factors beyond his control
• faced overtime situations
• Substandard direct materials
• Purchasing aggressively sought discounts, even
  at expense of quality
• Narrowly focuses on prices
• Promotes Silo mentality

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What is the appropriate role of budget in
performance evaluation ?

• An appropriate budget should
• Help set attainable and meaningful goals
• Should promote Effectiveness and Efficiency
• Help promote enthusiasm, creativity and
  productivity
• Help management attain better results
• Budget over runs and variances should be one of
  the parameters but not the only parameter for
  performance evaluation
• Use budget based on standard cost system for
  evaluation guidelines
• dont look for scapegoats!!!
• Not be not thrust upon the people

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Recommendations and modifications for the
incentive plan

• Distribute profits to all employees on profit
  sharing basis instead of just the managers.
• Incorporate other variances that look at quality
  and inventory situations along with price.
• Quality variance (Input)
• Raw Materials Inventory variance
• Quality variance (output)
• Materials price variance is an important concern,
  but over emphasis on price may ignore quality
• Updating the management responsibility
• Use benchmarking Look to industry standards and
  gauge yourself

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Questions?
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Overhead control implications of Activity Costing
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Variable Overhead Variance Analysis
Actual Quantity Actual Quantity
Standard Quantity

Actual OH Rate Standard OH Rate
Standard OH Rate
SpendingVariance
EfficiencyVariance
The total variance is the flexible budget
variance.
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Some interesting facts..

• Surveys of Fortune 500 Companies from about a
  decade ago, show that almost all firms use
  Standard cost overhead analysis.
• Most firms use labor focused costing system of
  1900s.
• Majority of firms don't breakdown overhead into
  its major cost elements.
• Problems with an emphasis on overhead spending
  and efficiency variances have continued through
  1990 in CMA exams.
• Standard costing variance analysis included in
  top ten of the most important topics covered in
  curriculum.

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1983 CMA on Overhead Variances
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Implications of the above analysis

• A signal that direct labor, the base is
  efficiently used.
• Overhead spending is greater than actual.
• Overhead usage is highly favorable.

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Additional Data
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Solution per detail data, Volume Driven Standards
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Comparison of Alternatives

• A large favorable overhead quantity variance
  replaced by unfavorable variance.
• A modest unfavorable Spending variance replaced
  by highly favorable variance.
• For Indirect Labor, indication is that untrained
  workforce was appropriately used at lesser hourly
  rates.
• The variance directions and proportions are same
  for both Indirect labor and supplies.

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Q1 Limitations of Standard Cost Overhead
Analysis

• Overhead pools are too aggregated, and allocation
  of overhead based on a single, probably
  irrelevant base leads to wrong results.
• Variance formulas are misapplied.
• Reliance on these can mislead into costly,
  incorrect decisions.
• Efficiency overhead, particularly is a misnomer
  as efficiencies are not in the use of overhead
  but rather in the use of the base itself.
• Traditional computations for overhead spending
  and efficiency variances yield meaningless
  outcomes but at a cost.
• Though it gives us the relationship between
  estimated and actual costs, it gives very little
  management information.
• It may be counter-productive, resulting in
  dysfunctional decisions and in a loss of
  credibility for other accounting reports.

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Reasons to change from SCS

• Overhead itself is a relatively larger cost.
• Statistical tools necessary to implement the
  above are much more widely understood by
  accountants than a few years ago.
• Widespread computer processing has made it
  economical to do statistical analyses and
  maintain detailed cost data bases.

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An Illustration

• Machine hours have been found to be the
  appropriate cost driver through Regression
  Analysis for the supplies.
• Though all models of the product have same direct
  labor hour, the more complex models(20) require
  many more machine hours than the basic high
  volume model.
• With a shift in mix from complex to basic models,
  less lubricants are needed(990 to 900 barrels).
• If top-management approved 75,000 (6,000 hrs at
  12.50) indirect labor budget and activity-based
  budget is 60,000 (4,800 at 12.50), then
  management is responsible for the sticky cost of
  15,000 (Management Decision Variance or
  Strategic Quantity Variance).

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Additional data
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Solution per detail data, Activity Driven
Standards
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Total Variance
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Q2 How does the Activity approach improve upon
the Standard Cost Analysis of Overhead?

• With overhead costs rising as a proportion of
  manufacturing costs, Activity approach will be
  more cost beneficial.
• Activity approach may make difference between
  profitable or unprofitable operations.
• Whenever activity based costing is appropriate
  for product cost determination, the same drivers
  should be equally relevant for cost control
  applications.

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Questions?
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Better information through the marriage of ABC
and traditional standard costing techniques
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A General Model for Variable Overhead Variance
Analysis

• Actual Quantity Actual Quantity
  Standard Quantity
  
  Actual OH Rate Standard OH Rate
  Standard OH Rate

SpendingVariance
EfficiencyVariance
The total variance is the flexible budget
variance.
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A General Model for Fixed Overhead Variance
Analysis

• Actual Fixed Fixed
  Fixed
• Overhead Overhead
  Overhead
  Incurred Budget
  Applied
  SH FR

Spending Variance
Volume Variance
FR Standard Fixed Overhead RateSH Standard
Hours Allowed
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Q 1. Why traditional standard costing and
variance analyses have severe limitations when
used to analyze overhead costs, but less so when
used to analyze direct materials and direct labor
costs.
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Reasons

• Overhead costs are increasing at a rate faster
  than production or sales volume in most
  companies.
• The traditional cost drivers DM, DL and
  Manufacturing Hrs are applied as the activity
  measure for OH.
• In doing so, overhead rates can reach 500 to
  1,000 percent of direct labor costs.
• A single activity measure cannot conform to all
  the factory O/H
• Applying a single overhead rate doesn't
  adequately represent all the forces that drive
  costs in a modern organization.
• Locating overhead costs to products this way
  provides managers with poor or incorrect
  information on the costs of organizational
  resources, especially distribution, engineering,
  and sales

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ABC MOLDING COMPANY

• Example of both the limitations of traditional
  standard O/H variance information and the
  improvements gained by incorporating ABC
  techniques.
• Consider a single injection molding machine and a
  single operator.
• Machine operator capable of producing 125 parts
  per hr over 20 eight hr shifts at full capacity.
• Expected production for the test month 18000
  parts with 2 set ups 8 hrs each.
• Three components of O/H costs cost of operator,
  cost of indirect materials (cleaning solvent) and
  cost of utilities (electricity)
• Operator sets up machine and then monitors during
  production run
• Cleaning solvent used as part of set up
• Electricity consumed during production hr
• Actual production in test month was 16000 parts
  with 4 set ups 120 prod hrs and 50 set up hrs

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ABC MOLDING COMPANY DATA

• BUDGETED INFORMATION

ACTUAL INFORMATION
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ABC MOLDING COMPANY DATA
Expected VMOH _at_ actual cost driver level
calculations
Flexible Budget calculations
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Variances Based on Traditional Standard Variable
O/H Cost Analysis
2.22 extra set ups (4 vs. 1.78) more hrs to
perform 4 set ups (50 Vs 32 )
16000 parts in 8 fewer hrs (120 vs. 128)
Incr in price (0.07 Vs 0.06 per KW hr
efficiency 4800 more KW hrs (16800 vs. 12000 kw
hr)
2.22 extra set ups and less solvent (16 g Vs 24)
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Variances Based on Traditional Standard Fixed O/H
Cost Analysis
2 extra set ups, extra hrs (50 vs. 32) incr
operator costs (21 vs. 20)
2 extra set ups,less solvent usage(16 vs. 24)
incr in solvent cost (60 vs. 48)
2000 fewer parts produced.
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Q 2.How can the marriage of ABC and traditional
standard costing techniques improve usefulness of
information?
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Standard costing Vs. ABC

• As manufacturing becomes overhead intensive the
  information limitations produced by traditional
  analysis become severe.
• The traditional cost drivers DM, DL and
  Manufacturing Hrs do not adequately represent all
  the forces that drive costs in a modern
  organization.
• Traditional standard costing systems lack two
  necessary managerial functions
• -an accurate cost estimate for activities,
  products, services, and customers
• -economic feedback to managers and operators
  about process efficiency
• ABC System based on cost drivers that link
  activities performed to products and allocate
  activity costs directly to products using these
  cost drivers.
• ABC produces more accurate costs by using
  multiple drivers (basic and second level cost
  drivers) and multiple variable overhead rates

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Standard costing Vs. ABC

• ABC accurately measure costs but ignores the
  benefits of a multi-product production strategy.
• Updating the accounting system and maintaining an
  ABC system requires
• additional time and money compared to standard
  costing.
• ABC is useful for decision making but not
  decision control.
• Standard costing is the classic control tool. It
  sets out standard or expected costs for each
  category and then after the fact, one compares
  actual to budgets to identify variances
• The marriage of the ABC and traditional standard
  costing system represents the building block of
  a system capable of producing more relevant
  information

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Calculations- Unit level O/H costs

• Expected OH _at_ actual SDC level calculation
• 16800Kw hrs _at_ 0.06 per KW hr 1008
• Expected OH _at_ actual BCD level calculation
• 120 production hrs _at_ 20 per hr 2400
• 120 production hrs _at_ 100 Kw hrs per production
  hr _at_ 0.06 per kw hr 720
• Flexible Budget calculations
• 16000 parts _at_125 parts per production hr _at_ 20
  per hour 2560
• 16000 parts _at_ 125parts per production hr _at_ 100kw
  hrs per production hr _at_ 0.06 per Kw hour 768

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Variances Based on ABC Standard O/H Cost Analysis
Unit level O/H costs
Incr electricity consumption for 120 prod hrs
Decr in cost 16000 parts in fewer hrs than
expected.
Incr in KW hr price than expected.
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Calculations- Batch level O/H costs

• Expected OH _at_ actual BCD level calculation
• 50 hrs _at_ 20 per hr 1000
• 16 gallons _at_ 48 per gallon 768
• Batch level flexible budget calculation
• 4 set ups _at_8 hrs per set up _at_ 20per hr 640
• 4 set ups _at_ 6 gallons per set up _at_ 48 per
  gallon 1152
• Unit level Flexible Budget calculations
• 16000 parts _at_ 1 set up per 9000 parts_at_ 8 hrs per
  set up _at_ 20 per hr 284
• 16000 parts _at_ 1 set up per 9000 parts_at_ 6 gallons
  per set up _at_ 48 per gallon 512

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Variances Based on ABC Standard O/H Cost Analysis
Batch level O/H costs
18 more hrs used for 4 set ups (50 Vs 32)
8 less gallons used for 4 set ups (16 vs. 24)
Set up cost per part incr when produced in small
batches (4000 vs. 9000)
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Requirements

• Continually update the standard quantities and
  prices of inputs. Variations due to continual
  improvement, learning curves and business
  environment changes.
• Need additional information hence improve
  existing information systems. Information like
  monitoring utility consumption for each
• Calculate both basic and second level cost
  drivers for batch level O/H costs.

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Benefits

• It is a system building block to gain more
  relevant information.
• Focus on correcting the inefficiency
• Management can focus on potential areas for
  significant cost reduction.
• Low cost monitoring and low cost means for
  identifying potential improvements

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Conclusion

• The cost accountant must understand the
  strengths and weaknesses of each tool and be able
  to help managers decide when and for what purpose
  which tool is the best. There are no perfect
  answers in management accounting, all one can
  hope for is to address the ever-changing
  information needs of control and coordination
  activities that managers must perform.

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Questions?