Part 1

Study Unit 7.6 -7.8

Review
Cost Accumulations Methods
How much is controllable / How much is uncontrollable?
The production volume variance is due to

A Inefficient or efficient use of direct labor hours.

B Efficient or inefficient use of variable overhead.

C Difference from the planned level of the base used for

overhead allocation and the actual level achieved.

D Excessive application of direct labor hours over the standard

amounts for the output level actually achieved.
The production volume variance is due to

A Inefficient or efficient use of direct labor hours.

B Efficient or inefficient use of variable overhead.

C Difference from the planned level of the base used for

overhead allocation and the actual level achieved.

D Excessive application of direct labor hours over the standard

amounts for the output level actually achieved.
A fixed overhead volume variance based on standard
direct labor hours measures

A Deviation from standard direct labor hour capacity.

B Deviation from the normal, or denominator, level of direct

labor hours.

C Fixed overhead efficiency.

D Fixed overhead use.

A fixed overhead volume variance based on standard direct labor hours
measures

A Deviation from standard direct labor hour capacity.

B Deviation from the normal, or denominator, level of direct labor hours.

C Fixed overhead efficiency.

D Fixed overhead use.

Correct Answer: B
The fixed overhead volume variance measures the effect of not operating at the
budgeted (denominator) activity level. It is the difference between budgeted fixed
costs and the product of the standard fixed overhead application rate and the
standard activity level for the actual output. A favorable variance means that activity
was greater than expected and that fixed overhead was overapplied. It might be
caused by, for example, hiring more workers to provide an extra shift. An unfavorable
volume variance means that activity was less than budgeted (overhead was
underapplied), for example, because of insufficient sales or a labor strike.
Accordingly, the volume variance is usually outside the control of production
management. Moreover, unlike other variances, it does not directly reflect a
difference between actual and budgeted expenditure of resources.
Cordell Company uses a standard cost system. On January 1
of the current year, Cordell budgeted fixed manufacturing
overhead cost of $600,000 and production at 200,000 units.
During the year, the firm produced 190,000 units and
incurred fixed manufacturing overhead of $595,000.

The production volume variance for the year was

A $5,000 unfavorable.
B $10,000 unfavorable.
C $25,000 unfavorable.
D $30,000 unfavorable.
Cordell Company uses a standard cost system. On January 1 of the current year,
Cordell budgeted fixed manufacturing overhead cost of $600,000 and production at
200,000 units. During the year, the firm produced 190,000 units and incurred fixed
manufacturing overhead of $595,000.

The production volume variance for the year was

A $5,000 unfavorable.
B $10,000 unfavorable.
C $25,000 unfavorable.
D $30,000 unfavorable.

Correct Answer: D
The application rate for fixed overhead is $3.00 per unit ($600,000 budgeted
cost ÷ 200,000 budgeted units). The actual amount applied was $570,000
(190,000 actual units × $3.00 application rate). The production volume
variance was thus $30,000 unfavorable ($570,000 – $600,000).
Highlight, Inc. uses a standard cost system and applies
factory overhead to products on the basis of direct labor
hours. If the firm recently reported a favorable direct
labor efficiency variance, then the

A Variable overhead spending variance must be favorable.

B Variable overhead efficiency variance must be favorable.

C Fixed overhead volume variance must be unfavorable.

D Direct labor rate variance must be unfavorable.

Highlight, Inc. uses a standard cost system and applies
factory overhead to products on the basis of direct labor
hours. If the firm recently reported a favorable direct labor
efficiency variance, then the

A Variable overhead spending variance must be favorable.

B Variable overhead efficiency variance must be favorable.
C Fixed overhead volume variance must be unfavorable.
D Direct labor rate variance must be unfavorable.

Correct Answer: B
Highlight uses direct labor hours as the driver for variable overhead
application. Thus, if the direct labor efficiency variance was favorable, the
variable overhead efficiency variance must be favorable as well since the
two variances are based on the same standard and actual hours.
The JoyT Company manufactures Maxi Dolls for sale in toy stores. In planning for this
year, JoyT estimated variable factory overhead of $600,000 and fixed factory
overhead of $400,000. JoyT uses a standard costing system, and factory overhead is
allocated to units produced on the basis of standard direct labor hours. The
denominator level of activity budgeted for this year was 10,000 direct labor hours,
and JoyT used 10,300 actual direct labor hours.

Based on the output accomplished during this year, 9,900 standard direct labor hours
should have been used. Actual variable factory overhead was $596,000, and actual
fixed factory overhead was $410,000 for the year. Based on this information, the
variable overhead spending variance for JoyT for this year was

A $24,000 unfavorable.
B $2,000 unfavorable.
C $4,000 favorable.
D $22,000 favorable
The JoyT Company manufactures Maxi Dolls for sale in toy stores. In planning for this year, JoyT
estimated variable factory overhead of $600,000 and fixed factory overhead of $400,000. JoyT
uses a standard costing system, and factory overhead is allocated to units produced on the basis
of standard direct labor hours. The denominator level of activity budgeted for this year was
10,000 direct labor hours, and JoyT used 10,300 actual direct labor hours.

Based on the output accomplished during this year, 9,900 standard direct labor hours should
have been used. Actual variable factory overhead was $596,000, and actual fixed factory
overhead was $410,000 for the year. Based on this information, the variable overhead spending
variance for JoyT for this year was

A $24,000 unfavorable.
B $2,000 unfavorable.
C $4,000 favorable.
D $22,000 favorable

Correct Answer: D
The standard application rate for variable overhead is $60.00 per direct labor hour
($600,000 budgeted ÷ 10,000 budgeted direct labor hours). The variable overhead
spending variance can thus be derived by using the following formula:
Variable overhead efficiency variance
(AQ × SP) – Actual costs incurred
(10,300 × $60.00) – $596,000 = $22,000 F
Howard Company produces and sells replacement parts for
cotton processing equipment. Which one of the following
cost variances are least likely to be controllable by Howard’s
production manager?

A Variable overhead spending variance.

B Labor efficiency variance.
C Materials quantity variance.
D Fixed overhead production volume variance.
Howard Company produces and sells replacement parts for cotton processing
equipment. Which one of the following cost variances are least likely to be
controllable by Howard’s production manager?

A Variable overhead spending variance.

B Labor efficiency variance.
C Materials quantity variance.
D Fixed overhead production volume variance.

Correct Answer: D
The fixed overhead production volume variance is the difference between the
static/flexible budget for fixed overhead and the amount allocated based on the
budgeted allocation rate and the driver level allowable for the actual production
level achieved. None of these factors are under the control of the production
manager.
Brannen Videotronics uses a four-way allocation of overhead, machine hours to
allocate overhead, and years of experience as the main determinant for wage
increases. The standards are set and revised on an annual basis. Due to a surge
in competitive pressures, Brannen’s management decided to undertake
downsizing. Brannen offered incentives that permitted a large number of senior
employees to opt in the middle of the year for early retirement. As a result,
Brannen had to bring in temporary replacements who were paid entry-level
wages to see that work deadlines were met. Which one of the following is most
likely to result from this situation?

A Unfavorable efficiency variances and favorable price variances.

B Unfavorable efficiency variances and unfavorable price variances.
C Favorable efficiency variances and unfavorable price variances.
D Favorable efficiency variances and favorable price variances.
Brannen Videotronics uses a four-way allocation of overhead, machine hours to
allocate overhead, and years of experience as the main determinant for wage
increases. The standards are set and revised on an annual basis. Due to a surge
in competitive pressures, Brannen’s management decided to undertake
downsizing. Brannen offered incentives that permitted a large number of senior
employees to opt in the middle of the year for early retirement. As a result,
Brannen had to bring in temporary replacements who were paid entry-level
wages to see that work deadlines were met. Which one of the following is most
likely to result from this situation?

A Unfavorable efficiency variances and favorable price variances.

B Unfavorable efficiency variances and unfavorable price variances.
C Favorable efficiency variances and unfavorable price variances.
D Favorable efficiency variances and favorable price variances.

Correct Answer: A
The use of less-skilled workers will generally result in unfavorable labor efficiency
variances. However, this is accompanied by favorable labor rate (or price)
variances, which result from paying lower wages.
 Study Unit 8

Responsibility Accounting
And Performance Measures

By Jim Clemons, CMA

 8.1 - Responsibility Centers
• Centralized / decentralized organizations
– Amount of freedom of decision making by
managers.
• Centralized – more effectively coordinated from the
top.
• Decentralized – Decision at lowest level.
• Local manager makes more informed decision.
 8.1 - Responsibility Centers
• Responsibility center (SBUs)
– A decentralized organization is divided into
responsibility centers (or SBUs)
• Used to facilitate local decisions.
• Four types
– Cost center – Responsible for cost only.
» Cost drivers are relevant performance measures.
» Disadvantages – LT disregard, allocations of SDs.
» Service center that serve a specialized purpose.
– Revenue center – Responsible for revenues only.
» Performance measures are revenue drivers
» Examples of RC is a sales department
8.1 - Responsibility Centers
• Profit center – Responsible for both revenue and
expenses.

• Investment center – Responsible for revenues,

expenses, and invested capital.
– Allows for ROI analysis based on effectiveness of asset
usage.
– Can be easily compared to other Investment Centers or
Invesments.

• Each center under one manager

– Measures designed to monitor performance of center
8.1 - Performance Measures and
Manager Motivation
• Controllability – Manager’s incentive items
– Those that the manager can influence over time.
• Some cost cannot be traced to particular activity
• Not synonymous with variable cost
• Level of influence goes up with title.
– Common cost not under manager’s control.
• Goal congruence – Measures designed to tie manager’s
goals with company goals.
– Suboptimization results when goals are in segment’s own
interest
– Manager must be granted enough authority factors that
affect incentive package.
 8.1 - Responsibility Centers
• Cost Center and Revenue Centers
– Most appropriate performance measurement
technique for cost and revenue center managers is
variance analysis.
– PM should be based on cause-and-effect between
driver and output.
• Profit Centers
– Contribution margin approach is useful in profit
center performance measurement.
• Isolates variable and fixed costs
– Review page 294
 SU 8.1 Question 1

Fairmount, Inc., uses an accounting system that

charges costs to the manager who has been
delegated the authority to make the decisions
incurring the costs. For example, if the sales
manager accepts a rush order that will result in
higher-than-normal manufacturing costs, these
additional costs are charged to the sales manager
because the authority to accept or decline the rush
order was given to the sales manager. This type of
accounting system is known as

A. Responsibility accounting.
B. Functional accounting.
C. Reciprocal allocation.
D. Transfer price accounting.
 SU 8.1 Question 1 Answer
Correct Answer: A

In a responsibility accounting system, managerial performance should be evaluated only on the

basis of those factors directly regulated (or at least capable of being significantly influenced) by
the manager. For this purpose, operations are organized into responsibility centers. Costs are
classified as controllable and noncontrollable, which implies that some revenues and costs can
be changed through effective management. If a manager has authority to incur costs, a
responsibility accounting system will charge them to the manager’s responsibility center.
However, controllability is not an absolute basis for establishment of responsibility. More than
one manager may be able to influence a cost, and responsibility may be assigned on the basis of
knowledge about the incurrence of a cost rather than the ability to control it.

Incorrect Answers:

B: Functional accounting allocates costs to functions regardless of responsibility.

C: Reciprocal allocation is a means of allocating service department costs.
D: Transfer price accounting is a means of charging one department for products acquired
from another department in the same organization.
 SU 8.1 Question 2

The least complex segment or area

of responsibility for which costs are
allocated is a(n)

A. Profit center.

B. Investment center.

C. Contribution center.

D. Cost center.
 SU 8.1 Question 2 Answer
• Correct Answer: D
A cost center is a responsibility center that is accountable only for costs. The cost
center is the least complex type of segment because it has no responsibility for
revenues or investments.

Incorrect Answers:
A: A profit center is a segment responsible for both revenues and costs. A profit
center has the authority to make decisions concerning markets and sources of
supply.
B: An investment center is a responsibility center that is accountable for
revenues (markets), costs (sources of supply), and invested capital.
C: A contribution center is responsible for revenues and variable costs, but not
invested capital.
 SU 8.1 Question 3
Overtime conditions and pay were recently set by the
human resources department. The production
department has just received a request for a rush
order from the sales department. The production
department protests that additional overtime costs
will be incurred as a result of the order. The sales
department argues that the order is from an
important customer. The production department
processes the order. To control costs, which
department should never be charged with the
overtime costs generated as a result of the rush
order?

A. Human resources department.

B. Production department.
C. Sales department.
Shared by production department
D.
and sales department.
 SU 8.1 Question 3 Answer
Correct Answer: A

The sales department should be responsible for the overtime costs because it can best
judge whether the additional cost of the rush order is justified. The production
department also may be held responsible for the overtime costs because charging the full
overtime cost to the sales department would give the production department no
incentive to control these costs. However, the human resources department would never
be charged with the overtime costs because it has no effect on the incurrence of
production overtime.

Incorrect Answers:

B: To control costs, the production department may be charged with the overtime
costs.

C: To control costs, the sales department may be charged with the overtime costs.

D: The sales department and the production department may be charged with the
overtime costs.
 8.2 - Performance Measures
• Cost Centers and Revenue Centers
– Variance analysis is the most appropriate for cost and
revenue centers
– Performance measures should be based on cause and
effect
– Can be quantitative or qualitative
• Profit Centers
– Contribution margin is a good metric for profit
centers, which isolates effects of variable and fixed
costs (which are manages choices)
– Can show various intermediate measures (see
example)
8.2 - Performance Measures
• Segment Reporting
– Is a product line, geographical area, or other
meaningful subunit of the organization.
• CM analysis most useful for decision making.
• Examples include product, office or customer
• Review page 295 - 296 b, c and d
 SU 8.2 – Question 1

The segment margin of the Wire

Division of Lerner Corporation should
not include

A. Net sales of the Wire Division.

Fixed selling expenses of the Wire
B.
Division.
Variable selling expenses of the Wire
C.
Division.
The Wire Division’s fair share of the
D.
salary of Lerner Corporation’s president.
 SU 8.2 – Question 1 Answer
• Correct Answer: D
Segment margin is the contribution margin for a segment of a business minus fixed
costs. It is a measure of long-run profitability. Thus, an allocation of the corporate
officers’ salaries should not be included in segment margin because they are
neither variable costs nor fixed costs that can be rationally allocated to the
segment. Other items that are often not allocated include corporate income taxes,
interest, company-wide R&D expenses, and central administration costs.

Incorrect Answers:
A: Sales of the division would appear on the statement.
B: The division’s fixed selling expenses are separable fixed costs.
C: Variable costs of the division are included.
 SU 8.2 – Question 2
When using a contribution margin
format for internal reporting purposes,
the major distinction between
segment manager performance and
segment performance is

A. Unallocated fixed costs.

Direct variable costs of producing the
B.
product.
Direct fixed costs controllable by the
C.
segment manager.
D. Direct fixed costs controllable by others.
 SU 8.2 – Question 2 Answer
• Correct Answer: D
The performance of the segment is judged on all costs assigned to it, but the
segment manager is only judged on costs that he or she can control. Some fixed
costs are imposed on segments by the organization’s upper management, and they
are thus beyond the segment manager’s control. These direct costs controllable by
others make up the difference between segment manager performance and
segment performance.

Incorrect Answers:
A: Unallocated fixed costs do not affect either performance measure.
B: Direct variable costs affect both performance measures.
C: Direct fixed costs controllable by the segment manager affect both
performance measures.
 SU 8.2 – Question 3
Harris Co.’s income statement for
profit center No. 12 for August
includes
Contribution margin $84,000
Manager’s salary 24,000
Depreciation on accommodations 9,600
Allocated corporate expenses 6,000
The profit center’s manager is
most likely able to control which
of the following?
A. $84,000
B. $68,400
C. $60,000
D. $44,400
 SU 8.2 – Question 3 Answer
• Correct Answer: A
A profit center is a segment of a company responsible for both revenues and expenses. A profit
center has the authority to make decisions concerning markets (revenues) and sources of supplies
(costs). However, the profit center’s manager does not control his/her salary, investment and the
resulting costs (e.g., depreciation of plant assets), or expenses incurred at the corporate level.
Consequently, profit center No. 12 is most likely to control the $84,000 contribution margin (sales -
variable costs) but not the other items in the summarized income statement.

Incorrect Answers:
B: The profit center manager does not control depreciation on accommodations ($9,600) or the
allocated corporate expenses ($6,000).
C: The profit center manager does not control his/her $24,000 salary.
D: The profit center’s manager does not control the listed period expenses and therefore does
not control the profit center’s income.