Sim Dae-Acc213

Big Picture in Focus: ULOb.
apply the concept and objective of activity based

costing and management.
Metalanguage
In this section, the most essential terms relevant to the topic and to demonstrate
ULOb will be operationally defined to establish a common frame of reference as to
how the texts work in your chosen field or career.
1. Activity based costing (ABC) –is a costing method that is designed to
provide managers with cost information for strategic and other decisions that
potentially affect capacity and therefore “fixed costs”. ABC is ordinarily used
as a supplement to, rather than as a replacement for the company’s usual
costing system.
2. Activity based management (ABM) – is a discipline that focuses on the

activities incurred during the production/performance process as the way to
improve the value received by a customer and the resulting profit achieved by
providing this value.
Please proceed immediately to the “Essential Knowledge”.
Essential Knowledge
Cost are important in the business. Mismanagement of cost will affect the business
profitability and cash flow. To efficiently and effective control cost, management must
have a thorough knowledge and understanding of all activities and process
employed within the business to create value for the final product.
Activity based costing has been developed in response to the manager’s need for
more accurate product cost to make them more globally competitive. ABC helps
managers identify more clearly the costs involved in manufacturing a product or
providing a service and thereby provides more accurate unit cost information on
which to base pricing and other decisions.
1. Activity– is a repetitive action performed in fulfillment of business function.
2. Activity based Costing

• A costing system that allocates cost to products on the basis of the resources
consumed in each activity involved in the design, production and distribution
of a particular product.
• A process using multiple cost drivers to predict and allocate costs to products
and services
• An accounting system collecting financial and operational data on the basis of
the underlying nature and extent of business activities.
• An accounting information and costing system that identifies the various
activities performed in an organization, collects costs on the basis of the
underlying nature and extent of those activities, and assigns costs to products
and services based on consumption of those activities by the products and
services.
2.1. Benefits from ABC

• Improved productivity.
• The creation of a chart of the flow of activities through an organization.
• The identification and elimination (or reduction) of non value activities.
• The identification of causes of delay in performing activities.
• The ability to track indicators of waste.
2.2. Criticism of ABC

• Requires a significant amount of time and thus, cost to implement.
• It does not conform specifically to GAAP, since some non-products costs
(such as those in research and development) are allocated to products
and certain other traditionally designated product costs (such as factory
building depreciation) not be allocated to products.
• It does not promote TQM and continuous improvement.
2.3. Advantages and Limitations of ABC
Activity based costing provides several benefits to the manager, namely

1) More accurate product costs
2) Better data for decision making
3) Tighter cost control
3. Design of an ABC System
The step or activities required in designing an ABC are:
Process Value Analysis (PVA)
Identifying Activty Centers
Assigning Costs to Activity Centers
Selecting Cost Drivers
3.1. Step 1: Process Value Analysis involves the following steps:

a) Analyze activities required to make the product or perform the service.
This can be done through the preparation of a flowchart detailing each
in the manufacturing process from the receiving of materials to the final
inspection of the completed product.
b) Classify each activity as value-added or non-value-added.
c) Identify ways to either reduce or eliminate the non-value-added
activities.
3.1.1. Activity analysis – the process of detailing the various repetitive

actions that are performed in making a product or providing a service,
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classifying them as Value Added (VA) and Non – Value Added (NVA),
and devising ways of minimizing or eliminating NVA activities.
3.1.2. Classification of activities:

• Value Added activity (VA) – is an activity that increases the worth
of the product or service to the customer. The cost associated with
this activity is value added costs that cannot be eliminated without
the customer perceiving a decline in product quality or performance.
• Non Value Added activity (NVA) – is an activity that increases the
time spent on a product or services but does not increase its worth
or value to the customer. The cost related to this activity is called
non value added costs that can be eliminated without the customer
perceiving a decline in product quality or performance.
3.1.3. Value chain – is the sequence of business functions in which value is

added to a firm’s products or services. This sequences includes research
and development, product design, manufacturing, marketing, distribution
and customer service.
3.1.4. Process map – is a flowchart or diagram indicating every step that

goes into making a product or providing a service.
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3.1.5. Value chart – is a visual representation indicating the VA and NVA
activities and the time spent in those activities from the beginning to the
end of a process.
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3.2. Step 2: Identifying Activity Centers
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An activity center can be defined as a part of the production process for which
management wants a separate reporting if the cost of the activity involved.
Generally, the levels of activities can be classified into four as follows:
1. Unit – level activities – which are performed each time a unit is

produced.
2. Batch – level activities – which are performed each time a batch of
goods is handled or processed.
3. Product – level activities – which are performed as needed to support
the production of each different type of product.
4. Facility – level activities – which simply sustain a facility’s general
manufacturing process.
Unit – Level Activities

Activity Centers Cost Drivers Traceable Costs
Machine related activities Machine hours Power costs
Labor related activities Labor hours Maintenance costs
Number of units of output Labor costs
Factory supplies
Batch – Level Activities

Purchase order Number of orders Clerical costs
processing processed
Equipment setups Number of setups Supplies consumed
Material handling Hours of setup time Labor setup costs
Quality inspection Number of inspection Labor cost to handle
material
Hours of inspection time Quality control costs
Product – Level Activities

Product testing Number of tests Testing facility costs
Parts inventory Hours of testing time Parts administration costs
management
Product design Number of part types Parts carrying costs
Hours of design time Design costs
Facility – Level Activities

General factory Machine hours Plant depreciation
Plant occupancy Labor hours Property taxes &
insurance
3.3. Step 3: Assign Cost to Activity Centers
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Assign costs to the activity centers where they are accumulated while waiting to
be applied to products. Costs that are traceable to the activity center should be
assigned directly to activity centers. Other costs shared by two or more activity
centers should be assigned according to some cost driver that controls the
utilization of the costs involved.
3.4. Step 4: Select Cost Drivers
This involves assigning cists from the activity center to the product using
appropriate cost drivers. When selecting a cost driver, one must consider the
following factors
1) The ease of obtaining data relating to the cost driver
2) The degree to which the cost driver measures actual consumption by
products of the activity involved.
Sample Problem I: Application of Activity based costing
Barmaid Company provides the following ABC costing information:

Activities Total Costs Activity-cost drivers
Account inquiry hours P 400,000 10,000 hours
Account billing lines 280,000 4,000,000 lines
Account verification accounts 150,000 40,000 accounts
Correspondence letters 50,000 4,000 letters
The above activities are used by department A and Department B as follows:

Department A Department B
Account inquiry hours 2,000 hours 4,000 hours
Account billing lines 400,000 lines 200,000 lines
Account verification accounts 10,000 accounts 8,000 accounts
Correspondence letters 1,000 letters 1,600 letters
I. Compute for the ABC rate.
Activities Total Cost Rate

Costs Driver
Account inquiry hours 400,000 ÷ 10,000 = P 40 per hour
Account billing lines 280,000 ÷ 4,000,000 = P 0.07 per line
Account verification accounts 150,000 ÷ 40,000 = P 3.75 per accounts
Correspondence letters 50,000 ÷ 4,000 = P 12.50 per letter
II. Allocate factory overhead.
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DEPARTMENT A
Activities Cost Rate Factory Overhead
Driver
Account inquiry hours 2,000 X P 40 = P 80,000
Account billing lines 400,000 X P 0.07 = 28,000
Account verification accounts 10,000 X P 3.75 = 37,500
Correspondence letters 1,000 X P 12.50 = 12,500
TOTAL P 158,000.00
DEPARTMENT B
Activities Cost Rate Factory Overhead
Driver
Account inquiry hours 4,000 X P 40 = P 160,000
Account billing lines 200,000 X P 0.07 = 14,000
Account verification accounts 8,000 X P 3.75 = 30,000
Correspondence letters 1,600 X P 12.50 = 20,000
TOTAL P 224,000.00
Sample Problem II: Application of Activity based costing

Food Corner Supermarket found that its ABC analysis provided important insights. It
extends the analysis to cover three more product lines – breads, soft drinks, ice
cream. The revenues, cost of goods sold, store support costs and activity area
usage of the three product lines is as follows:
Breads Soft drinks Ice cream

Financial data
Revenues P 57,000 P 63,000 P 52,000
Cost of goods sold 38,000 47,000 35,000
Store support 11,400 14,100 10,500
Activity area usage (cost driver)

Ordering (purchase orders) 30 25 13
Delivery (deliveries) 98 36 28
Shelf-stocking (hours) 183 166 24
Customer support (item sold) 15,500 20,500 7,900
Required:
I. Use the ABC system to compute a product line profitability report for Food
Corner.
Note: ordering at P100 per purchase order, delivery at P80 per delivery, shelf-
stacking at P20 per hour and customer support at P0.20 per item sold
Solution: Food Corner Supermarket
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The ABC system reports the following
Breads Soft drinks Ice cream Total

Revenues P 57,000 P 63,000 P 52,000 P 172,000
Costs
Cost of goods sold 38,000 47,000 35,000 120,000
Ordering (purchase orders) 3,000 2,500 1,300 6,800
Delivery (deliveries) 7,840 2,880 2,240 12,960
Shelf-stocking (hours) 3,660 3,320 480 7,460
Customer support (item sold) 3,100 4,100 1,580 8,780
TOTAL COSTS 55,600 59,800 40,600 156,000
Operating income P 1,400 P 3,200 P 11,400 P 16,000
Net profit margin 2.46% 5.08% 21.92% 9.30%

These activity costs are based on the following:
Breads
Activity Cost allocation rate Activity level Costs
Ordering P100 per purchase 30
P 3,000
order
Delivery P80 per delivery 98 7,840
Shelf-stacking P20 per hour 183 3,660
Customer P0.20 per item sold 15,500
3,100
support
Soft drinks
P 2,500
order
Shelf-stacking P20 per hour 166 3,320
4,100
support
Ice cream
P 1,300
order
Shelf-stacking P20 per hour 24 480
1,580
support
The ranking of products in terms of relative profitability are:

I. Ice cream
II. Soft drinks
III. Breads
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4. ACTIVITY BASED MANAGEMENT
4.1. Activity based management (ABM) – is a management tool that involves

analyzing and costing activities with the goal of improving efficiency and
effectiveness. Basically, this management approach aims to improve the
value of products or services to customers and increase the firm’s profit.
There are two categories of ABM application, namely:

1. Operational ABM – enhances operation efficiency and asset utilization
and lowers costs. It focuses on doing things right and performing
activities more efficiency.
2. Strategic ABM – attempts to alter the demand for activities and
increase profitability at the current or improved activity efficiency. If
focuses on choosing the activities for the operations.
Moreover, ABM uses cost driver analysis, activity analysis and performance
measurement to improve operations. A brief explanation of these techniques
follows:
4.2. Cost driver analysis

This technique examines, quantifies and explains the effects of the costs driver
on the costs of an activity. Its purpose is to search for the root cause of activity
costs. Among the tools used in cost driver analysis include benchmarking, cause-
and-effect diagrams and pareto analysis.
Benchmarking – involve the search for the best practices anywhere to
identify ways to improve the operation for a task, activity or process.
Cause-and-effect diagrams– maps out causes that affect an activity,
process, stated problem or desired outcome.
Pareto analysis – is a histogram of the cost driver that contribute to the total
cost.
4.3. Activity analysis

To be competitive a firm must assess each of its activities based on its need by
the product or customer, its efficiency and its value content. A firm performs an
activity because it is:
• Required to meet the specification of the product or service or satisfy
customer demand.
• Required to sustain the organization
• Deemed beneficial to the firm.
Activity analysis identifies and describes the activities in an organization.
4.4. Performance measurement

This involves the identification of the work performed and the results achieved by
an activity process or organizational unit. Performance measures include both
financial and nonfinancial. Financial performance measures are cost per unit of
output, return on sales and cost of every department.
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Nonfinancial performance measure evaluate operating characteristics of
manufacturing process and measures of or feedbacks from customers or
personnel. Examples of nonfinancial performance measures are the:
• Number of customer complaint
• Customer satisfaction
• Number of defective parts or output
• Number of output unit
• Cycle time
Let’s Check!
I. Questions:
1. When designing an activity based costing system, why should PVA always
be the starting point?
________________________________________________________
________________________________________________________
________________________________________________________
2. What are the major advantages of activity based management (ABM)?

________________________________________________________
________________________________________________________
________________________________________________________
3. What four general levels of activity can be identified in a company?

________________________________________________________
________________________________________________________
________________________________________________________
II. True or False

Write “TRUE” if the statement is true otherwise write “FALSE” if the statements is
incorrect.
_____ 1. A company should strive to reduce all non-value added activities to
a minimum.
_____ 2. Activity-based costing is appropriate for a company that has low
overhead costs that are proportional to the unit volumes of
products.
_____ 3. An activity-based costing system should be evaluated with regard
to the benefits it can provide an organization versus the costs of
implementing it.
_____ 4. Machine setup is normally considered a unit-level cost
_____ 5. Preparation of a value chart is the first step in activity analysis
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III. Multiple choice
Encircle the letter that correspond to your answer.
1. Activity-based costing
a) requires the identification of cost drivers.
b) is used only in JIT operations.
c) applies only to discretionary fixed costs.
d) does not help to identify activities as value-adding or non-value-adding.
2. A company using activity-based costing

a) tries to identify cost drivers.
b) allocates all costs to individual products.
c) looks for the activity with which total costs are most closely associated.
d) is probably using the JIT philosophy.
3. A tool that focuses on manufacturing processes and seeks to reduce or optimize

the activities performed within the process is
a) process value analysis
b) re-engineering
c) caveat analysis
d) benchmarking
4. Kimball Company produces two products in a single factory. The following

production and cost information has been determined:
Model 1Model 2
Units produced 1,000 200
Material moves (total) 100 40
Testing time (total) 250 125
Direct labor hours per unit 1 5
The controller has determined total overhead to be P480,000. P120,000 relatesto

material moves; P150,000 relates to testing; the remainder is related to labor
time.
If Kimball uses direct labor hours to allocate overhead to each model, what would
overhead per unit be for Model 1?
a) P10.00
b) P120.00
c) P240.00
d) P400.00

Model 1Model 2
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The controller has determined total overhead to be P480,000. P120,000 relatesto
material moves; P150,000 relates to testing; the remainder is related to labor
time.
If Kimball uses activity-based costing to allocate overhead to each model, what
would overhead per unit be for Model 1?
a) P400.00
b) P295.00
c) P240.00
d) P120.00

Model 1Model 2
The controller has determined total overhead to be P480,000. P120,000

relatesto material moves; P150,000 relates to testing; the remainder is related to
labor time.
If Kimball uses direct labor hours to allocate overhead to each model, what
a) P158.33
b) P400.00
c) P950.00
d) P1,200.00

Model 1Model 2
The controller has determined total overhead to be P480,000. P120,000

relatesto material moves; P150,000 relates to testing; the remainder is related to
labor time.
If Kimball uses activity-based costing to allocate overhead to each model, what

a) P158.33
b) P415.93
c) P925.00
d) Some other number
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Let’s Analyze
LDR Corporation makes ultra-lightweight backpacking tents. Data concerning the
company’s two product lines appear below:
Special Regular
Direct materials per unit P60.00 P45.00
Direct labor per unit P9.60 P7.20
Direct labor-hours per unit 0.8 DLHs 0.6 KHs
Estimated annual production 10,000 units 70,000 units
The company has a traditional costing system in which manufacturing overhead is

applied to units based on direct labor hours. Data concerning manufacturing
overhead and direct labor hours for the upcoming year appear below:
Estimated total manufacturing overhead P290,000
Estimated total direct labor hours 50,000
Required:
1. Determine the unit product costs of the Special and Regular products under the
company’s traditional costing system.
2. The company is considering replacing its traditional costing system for
determining unit product costs for external reports with an activity based costing
system. The activity based costing system would have the following three activity
cost pools:
Estimated Expected Activity

Activities and activity measures Overhead Special Regular Total
Costs
Supporting direct labor (direct labor hours) P 150,000 8,000 42,000 50,000
Batch setups (setups) 60,000 200 50 250
Safety testing (tests) 80,000 80 20 100
Total manufacturing overhead costs P 290,000
Determine the unit product costs of the special and regular products under the
activity based costing system.
In a Nutshell
As the chief executive officer of a large corporation, you have made a decision after
discussion with production and accounting personnel to implement activity-based
management concepts. Your goal is to reduce cycle time and, thus, costs. A primary
way to accomplish this goal is to install highly automated equipment in your plant,
which would then displace approximately 60 percent of your workforce. Your
company is the major employer in the area of the country where it is located.
a) Discuss the pros and cons of installing the equipment from the perspective of
your (1) stockholders, (2) employees, and (3) customers.
b) How would you explain to a worker that his or her job is non-value-added?
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c) What alternatives might you have that could accomplish the goal of reducing
cycle time but not create economic havoc for the local area?
Q&A List
Do you have any question for clarification?
Questions/Issues Answers
1.
2.
3.
4.
5.
Keywords index
Activity based costing Activity analysis
Activity based management Process value analysis
Cost driver
Self-help
You can also refer to the sources below to help you further understand the
lesson:
Cabrera, M. E. (2017). Management Accounting: Concepts and Application.

Manila: GIC Enterprises & Co., Inc.
De Leon, E.D., & De Leon N.D. (2016). Cost accounting. Manila: IC Enterprises &
Co., Inc.
Raiborn, C. A., & Kinney, M.R. (2014). Cost accounting (2014 second edition).
Philippines Hixes Press, Inc.
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Big Picture in Focus: ULOc.explain the concept of just in time and backflush
accounting.
Metalanguage
ULOcwill be operationally defined to establish a common frame of reference as to
1. Just in Time (JIT) – is a philosophy centered on the reduction of non-value
added costs through elimination of inventory.
o Purchasing – all materials and components should arrive at a
workstation when they are needed – no earlier and no later.
o Production – products should be completed and available to
customers when the customers want them – no earlier and no later.
2. Backflushing (backflush costing or backflush accounting) – is a costing

system that omits recording some or all of the journal entries.
Essential Knowledge
Management aims to have an efficient and effective procedures in the business

operation that will minimize costs and waste, and improve the quality of the product
or service. In manufacturing, ability to response the market and cost of production
can make or break a company. Management will make sure that its process are
adequate from a productive operation.
1. Just in time–is a workflow methodology aimed at reducing the flow times within
the production system and as well as the response time with suppliers and
customers JIT helps business firms control variability and allowing them to
improve productivity while reducing the costs.
1.1. Just in time system – is a comprehensive production and inventory system

that purchases or produces materials and parts only as needed and just in
time to be used at each stage of the production process.
1.2. Just in time production – is a system in which each component on a

production line is produced immediately as needed by the next step in the
production line.
Firms use the JIT method to minimize inventory and improve quality by carefully
coordinating the receipt of raw materials and the delivery of product with the
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manufacturing process in the plant. The goal is to have little or no raw material, work
in process, or finished goods inventory in the plant.
1.3. Cost associated with inventory

• Purchasing costs – the cost of goods acquired from suppliers, including
freight or transportation costs. Discounts for different purchase order sizes
and supplier credit terms affect purchasing costs.
• Ordering costs – the costs of preparing and issuing purchase orders,
receiving and inspecting items included in the orders, and matching
invoices received, purchase orders, and delivery records to make
payments. Ordering costs include the cost of obtaining purchase
approvals, as well as other special processing costs.
• Carrying costs – the costs that arise while holding inventory of gods for
sale. Carrying costs include the opportunity cost of the investment tied up
in inventory and the costs associated with storage, such as space rental,
insurance, obsolescence and spoilage.
• Stockout costs – these are costs that result when a company runs out of a
particular item for which there is customer demand – a stockout – and the
company must act quickly to meet that demand or suffer the costs of not
meeting it.
• Quality costs – these are costs that result when features and
characteristics of a product or service re not in conformance with customer
specifications.
1.4. Financial benefits of JIT
JIT tends to focus broadly on the control of total manufacturing costs instead of
individual costs such as direct manufacturing labor. JIT can provide many
financial benefits, including:
1. Lower investment in inventories
2. Reductions in carrying and handling costs of inventories
3. Reduction in risk of obsolescence of inventories.
4. Reductions in setup costs and total manufacturing costs
5. Reduction in costs of waste and spoilage as a result improves quality
1.5. Major features of JIT production system
There are main features in a JIT production system:

1. Production is organized in manufacturing cells.
Manufacturing cells – a grouping of all the different types of
equipment used to manufacture a given product.
2. Workers are trained to be multiskilled so that they are capable of
performing a variety of operations and tasks.
3. Total quality management is aggressively pursued to eliminate defects.
4. Emphasis is placed on reducing setup time.
5. Suppliers are carefully selected to obtain delivery of quality tested parts in
a timely manner.
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2. Backflush costing – is a simplified approach to determining product cost is that
is used when there is little or no work in process inventory. This method charges
current production costs directly to finished goods inventory without accounting
for the flows in and out of the work in process inventory account.
✓ This system is applicable to mature JIT system in which velocity is so high
that traditional accounting is impractical.
✓ It uses trigger point to determine when manufacturing costs are assigned to

key inventory and temporary accounts. Trigger point refer to a stage in the
cycle.
• Purchase of direct materials

Stage A
• Production resulting in WIP

Stage B
• Completion of good finished units of

Stage C products
• Sales of ginished goods

Stage D
✓ In backflush costing materials cost is combined with work in process into

single “Raw and In process” account, while direct labor and factory are
combined into a “Conversion costs” account which is applied to finished
goods or cost of goods sold.
Sample Problem I: Backflush costing
A brief illustration of backflush costing follows. Assume that a company has the
following information for a given month of activity.
Purchase of direct materials P 200,000

Direct materials used 180,000
Conversion costs incurred 250,000
Conversion costs applied 300,000
The inventory of direct materials increased by P20,000 (P200,000 – P180,000)

during the month and conversion costs were applied by P50,000 (P300,000 –
P250,000). The company charges overapplied or underapplied conversion cost to
cost of goods sold at the end of the year.
The journal entries to record
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1) The purchase of direct materials
2) The conversion costs incurred
3) The completion of finished product during the month follow.
Solution:
1. Raw and In process Inventory P 200,000
Accounts Payable (Cash) P 200,000
2. Conversion costs 250,000

Wages payable (other accounts) 250,000
3. Finished goods 480,000

Raw and In process Inventory 180,000
Conversion costs 300,000
Let’s Check!
I. Questions:
1. Explain why JIT production system simplify job costing?
________________________________________________________
________________________________________________________
________________________________________________________
2. Distinguish a demand – pull from a push – through system?

________________________________________________________
________________________________________________________
________________________________________________________
3. Describe the essence of backflush costing?

________________________________________________________
________________________________________________________
II. True or False

Write “TRUE” if the statement is true otherwise write “FALSE” if the statements is
incorrect.
_____ 1. In a push system of production control, inventory is produced in
anticipation of customer or work center demand.
_____ 2. In a just-in-time (JIT) environment, design changes may be made at
any time during the production process.
_____ 3. In a just-in-time (JIT) environment, end-of-period variance analysis
and reporting does not occur
_____ 4. In a just-in-time (JIT) environment, quality is determined continually
during the manufacturing process.
_____ 5. Backflush costing requires fewer allocations than traditional
accounting methods.
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1. JIT is a philosophy concerned with

a. when to do something.
b. how to do something.
c. where to do something.
d. how much of something should be done.
2. Joint costs are allocated to joint products to

a. obtain a cost per unit for financial statement purposes.
b. provide accurate management information on production costs of each
type of product.
c. compute variances from expected costs for each joint product.
d. allow the use of high-low analysis by the company.
3. When JIT is implemented, which of the following changes in the accounting

system would not be expected?
a. fewer cost allocations
b. elimination of standard costs
c. combining labor and overhead into one product cost category
d. combing raw material and materials in work-in-process into one product
cost category
ITEMS 4 – 6:
Hans Jensen, general manger of a Mr. Clean and Company, has provided the
following information for transaction that occurred during August. The production
plant uses JIT costing system.
• Raw materials were purchased at the cost of P97,000.

• Direct labor costs of P77,000 were incurred.
• Actual overhead costs amounted to P225,000.
• Applied conversion costs totaled to P300,000. This includes the direct
labor cost.
• All units are completed and immediately sold.
4. Determined the August 31 balance of Cost of Goods Sold account, no adjustment

has been made for over-applied or under-applied conversion cost.
a. P 697,000
b. P 397,000
c. P 399,000
d. P 699,000
5. Using the same information in no.4, what was the over-applied or under-applied
conversion cost for the month.
a. P5,000 over-applied c. P 2,000 over-applied
b. P 5,000 under-applied d. P2,000 under-applied
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6. Using the same information in no. 4 and 5, what is the Cost of Goods Sold after
all transactions-adjustments have been completed?
a. P 697,000
b. P 397,000
c. P 399,000
d. P 699,000
Let’s Analyze
The Pure Corporation manufacturers electrical meters. For August, there were no
beginning inventories of direct (raw) materials and no beginning and ending work in
process. Pure uses a JIT production system and backflush costing with two trigger
points for making entries in the accounting system:
• Purchase of direct materials debited to Inventory: Raw and In-process
Control
• Completion of goods finished units of product debited to Finished Goods
Control and standard costs
Pure August standard costs per unit are direct materials, P25; conversion costs,
P20. The following data apply to August manufacturing:
Direct (raw) materials purchased P 550,000
Conversion costs incurred P 440,000
Number of finished units manufactured 21,200
Number of finished units sold 20,000
Required:
I. Prepare summary journal entries for August (without disposing of
underapplied or overallocated conversion costs). Assume no direct materials
variances.
II. Post the entries in requirement I to T-accounts for applicable Inventory
Control, Conversion Costs Control, Conversion Costs Allocated, and Cost of
Goods Sold.
In a Nutshell
Canon Manufacturing Company began implementing a just-in-time inventory system
several months ago. The production and purchasing managers, however, have not
seen any dramatic improvements in throughput. They have decided that the
problems are related to their suppliers. The suppliers (there are three) seem to send
the wrong materials at the wrong times. Prepare a discussion of the problems that
might exist in this situation. Be certain to address the following items: internal and
external communications; possible engineering changes and their impacts; number,
quality, and location of suppliers; and length of system implementation.
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Q&A List
1.
2.
3.
4.
5.
Keywords index
Just in time Conversion costs
Backflush costing Trigger points
Raw and in-process account
Self-help
lesson:

Co., Inc.
Big Picture
Week 4&5: Unit Learning Outcomes (ULO): At the end of the unit, you are expected
to:
a. explain the concept offlexible and static budgeting.
22
b. apply the conceptstandard cost in measuring the operational performance of
the business.
Big Picture in Focus: ULOa.explain the concept offlexible and static

budgeting.
Metalanguage
ULOawill be operationally defined to establish a common frame of reference as to
1. Flexible budget – is a budget prepared for many levels of activity. It makes
possible the adjustment of the budget to the actual level of activity before
comparing the budget figures with the actual results.
2. Static budget –is a type of budget that anticipates a fixed amount in sales
and expenses. This type of budget allows company to allocate money to
resources that they expect to remain the same throughout the stated period.
Essential Knowledge
Budgeting is one of the most important financial habits that you can adopt. It is
important especially for businesses because it helps them track how much money
they spend, save and invest. Moreover, budgeting helps the firm to stay financially
organized, prepare for emergencies and maintain focus on the long term goals of the
firm.
1. Budgeting– is the process of creating a plan to strategically allocate the financial

resources of the firm
1.1. Budget – is a realistic plan, expressed in quantitative terms, for a certain

future period of time.
1.2. Advantages of Budgeting

▪ Budgets can be used by top management to communicate its plans and goals
throughout the organization.
▪ Budgets force management to thick about and plan for the future.
▪ Through budgeting, resources are more appropriately allocated.
▪ Budgeting promotes coordination of the activities of the entire organization.
1.3. Budget Committee– composed of key management persons who are

responsible for overall policy matters relating to the budget program and for
coordinating the preparation of the budget itself.
23
1.4. Master budget – encompasses the organization’s operating and financial
plans for a certain future period of time. It is composed of the operating
budget and financial budget.
1.5. Budget manual – describes how a budget is to be prepared. It usually

includes:
1. Budget planning calendar – the schedule of activities for the development
and adoption of the budget,
2. Distribution instructions for all budget schedules, so that those segments
involved in the budget preparation would know to whom/from whom a
computed budget schedule is to be given/acquired.
1.6. Budget report – shows a comparison of the actual and budget performance.
The budget variances, which are properly described as either favorable or
unfavorable, are also shown on the report.
2. Flexible budget – adjusts to changes in the actual revenue levels.
2.1. Steps in preparing a flexible budget

1. Identify all fixed costs and segregate them in the budget model.
2. Determine the extent to which all variable cost changes as activity level
(measure) changes.
3. Create the budget model where fixed costs are “hard coded”, while variable
costs are stated as a percentage of the relevant activity measures.
4. Enter actual activity measures into the budget model after a period has been
completed. This updates the variable costs in the flexible budget.
5. Enter the resulting flexible budget for the completed period into the accounting
system for comparison to actual expenses.
2.2. Advantages of Flexible Budgeting

a) Usage in variable cost environment
b) Performance measurement
c) Budgeting efficiency
2.3. Disadvantages of Flexible Budgeting

1) Formulation of the budget
2) Closing delay
3) Revenue comparison
4) Applicability
3. Static budget – is a budget that does not change with variations in activity levels.
3.1. Benefits of Static Budget

a) Helps to monitor expenses, sales and revenues.
b) Help organization achieve optimal financial performance
c) Serve as a guide or map for the overall direction of the company.
d) Serve as a mechanism to prevent overspending and match expenses (or
outgoing payment) with incoming revenue from sales.
24
3.2. Limitations of Static Budget
1) Constrained the ability of an organization to accurately forecast its needed
expenses.
2) There will be disparity between static budget and actual result if predictive
planning is not possible.
3) Static budget may be more effective for organizations that have highly
predictable sales and costs and for short term periods.
Let’s Check!
I. Questions:
1. Differentiate flexible budget and static budget.

________________________________________________________
________________________________________________________
________________________________________________________
2. What is the importance of budgeting in achieving the objectives of the

orgaization.
________________________________________________________
________________________________________________________
________________________________________________________
II. True or False:

Write “TRUE” if the statement is true otherwise write “FALSE” if the
statements is incorrect.
1) Fixed costs should not be included in a flexible budget since such

costs are not likely to be controllable by managers.
2) It is not important that the activity base and overhead costs be
causally related when developing a flexible budget.
3) The activity base for a flexible budget should usually be expressed
in units of activity rather than in dollars.
4) The static budget should be used primarily to determine whether
cost control is being maintained.
III. Multiple Choice:

1. When using a flexible budget, what will occur to fixed costs as the activity
level increases within the relevant range?
a. fixedcostsperunitwilldecrease.
b. fixedcostsperunitwillremainunchanged.
c. fixedcostsperunitwillincrease.
d. fixedcostsarenotconsideredinflexiblebudgeting.
25
2. A major disadvantage of static budgets is:
a. Thedifficultyindevelopingsuchbudgetsduetothehighcostofgatheri
ngthenecessary information.
b. Thecostbehaviorpatternofmanufacturingoverhead,whichisprimari
lyfixed.
c. Thatthevariancesbetweenactualandbudgetonastaticbudgetresult
fromcomparing actual costs at one level of activity to budgeted
costs at a different levelof activity.
d. Theirlengthandcomplexity.
3. Comparing actual results to a budget based on actual activity for the

period is possible with the use of a:
a. Monthly budget.
b. Masterbudget.
c. Flexible budget.
d. Rollingbudget.
4. A static budget is:

a. Abudgetforasinglelevelofactivity.
b. Abudgetthatignoresinflation.
c. Usedonlyforfixedcosts.
d. Usedwhenthemixofproductsdoesnotchange.
Let’s Analyze
Many managers believe that, if all amounts in their budgets are not spent during a
period, they will lose allocations in future periods and that little or no recognition will
result from cost savings.Discuss the behavioral and ethical issues involved in a
spend-it-or-lose-it attitude. Include in your discussion the issue of negotiating budget
allocation requests prior to the beginning of the period.
Q&A List
1.
2.
3.
4.
5.
26
Keywords index
Flexible budget
Static budget
Self-help
lesson:

Co., Inc.
Big Picture in Focus: ULOb.apply the conceptstandard cost in measuring

the operational performance of the business.
Metalanguage
ULObwill be operationally defined to establish a common frame of reference as to
1. Standard costs – represent what costs should be under attainable,
acceptable performance. They do not represent what the cost would be if
perfection in performance had actually been attained. Standards establish
desirable minimum costs.
2. Variance analysis–is a quantitative examination of the difference between
the planned and actual result. The variance analysis is used to maintain
control over the business.
Essential Knowledge
Proper control of costs requires a comparison of actual cost result with some base
data. Management is interested to know what costs are but also whether they
represent an efficient level of productive operations. To properly interpret and control
27
costs, we can compare actual costs with standard costs so we can study any
difference or variance.
1. Standards– are yardsticks that measure achievement or lack of achievement.

The standards relate to the quantity and cost of inputs used in manufacturing
goods or providing services.
• Quantity standard – indicate how much of a cost element, such as labor, time
raw materials should be used in manufacturing a unit of product or in
providing a unit of service.
• Cost standard – indicate what the cost of the time or the materials should be.
2. Standard cost – is the predetermined cost of manufacturing a single unit or a

number of product units during a specific period in the immediate future. It is a
planned cost of a product under current and/or anticipated operating conditions.
2.1. Uses of Standard Costs

Standard cost system help in planning operations and gaining insights into the
probable impact of managerial decisions on cost levels and profits. Specifically,
standard costs are used for:
1. Establishing budgets
2. Controlling costs
3. Motivating and measuring performance
4. Promoting cost awareness and cost reduction
5. Simplifying costing procedures and expediting cost reports
2.2. Benefits of standard costs

When standard cost are set carefully and used widely, they provide benefits to
and organization such as:
1. Managers and employees become cost conscious because variances
between standard costs and actual costs are reported, studied and their
causes are determined.
2. They aid management planning by providing the unit amount for
budgeting.
3. Standard cost systems integrate managerial, accounting and engineering
functions.
4. Using standard cost systems can save data processing costs.
2.3. Limitation of standard cost

Although the advantages of using standard costs are significant, certain
difficulties can also be encountered by the manager. The following are some of
the problems or potential problems in using standard costs:
1. Difficulty may be encountered in determined which variance are materials
or significant in amount to warrant investigation.
2. Other useful information such as trends may not be noticed at an early
stage since attention is focused only on variances above a certain level.
3. Subordinates may be tempted to cover up unfavorable exceptions or not
report them at all, particularly when they do not receive reinforcement or
commendation for the positive things they do.
28
3. Setting Direct Materials Standards
3.1. Standard Quantity

Industrial engineers develop specification for the kinds and quantities of materials
used in producing the goods budgeted. Operation schedules list the materials
and quantities required for the expected volume of production.
3.2. Standard Price

The purchasing department receives the operation schedule and bills of material
established jointly by the engineering department, the manufacturing supervisor
and the accountant. This information becomes the basis for the material price
standard.
Purchasing agents are responsible for price variances, they should help set the
price standards which should reflect the study of market conditions, vendors’
quoted prices and the optimum size of purchase order. The account should
consider cash discounts, material handling costs (freight in, purchasing, receiving
and other costs) in the standard price to be established.
4. Setting Labor Standards
4.1. Standard Time

Examination of past payroll and production records can reveal the worker – hours
used on various jobs and can help determine standard performance. Time
reports from the workers for a limited period will be a good basis for the standard.
4.2. Standard Labor Rate

Labor rates should be determined by considering the current rate as well as the
competitive markets. The company may use any of the following methods in
determining the labor rate standards:
1. A company may establish a standard rate for the job; regardless of who
performs the job, the rate stays the same, or
2. A company may establish a rate for an individual worker and the worker
receives this rate regardless of the work performed.
5. Setting Overhead Standards

Factory overhead cost standards provide a means of allocating factory overhead
to cost inventories for pricing decisions and controlling expense. A standard cost
system uses budgeted rates based on standard hours or other cost drivers
allowed for actual production. Standards set on practical capacity are likely to be
attainable and are more realistic that theoretical standards.
6. Variance – is the difference between actual costs and standard costs. To be

meaningful to users, the variance should be described as either favorable or
unfavorable.
29
a. Actual costs are more than the standard costs, the variance is
unfavorable.
b. Actual costs are less than the standard costs, the variance is favorable.
6.1. Direct Materials Variance Analysis
The difference between actual cost and standard cost of materials used is called
a material cost variance. This variance is made up of a price variance and a
quantity variance.
• Materials Price Variance (MPV) – is the difference between the price

actually paid and the standard price that should have been paid for the
quantity of materials actually purchased or used. This type of variance is the
responsibility of the purchasing department. The formula is:
MPV = (Actual Price – Standard Price) * Actual Quantity Purchased
• Materials Quantity Variance (MQV) – is the difference between the actual

units of materials used and the standard quantity allowed for actual
production. This type of variance is the responsibility of the production
department. The formula is:
MQV – (Actual Quantity Used – *Standard Quantity Allowed) * Standard Price
Note: Standard Quantity Allowed = (Actual production * SQM required per unit of
product)
The possible causes of material price variance are as follows:

1. Fluctuations in market prices of materials.
2. Purchasing from distant suppliers, which results in additional transportation.
3. Failure to take cash discount available.
4. Purchasing materials of substandard quality or in uneconomical lots.
5. Unfavorable purchase contract terms.
Responsibility: The Purchasing Department is usually responsible for material price

variances. However, the Production Planning Department could be responsible for
unfavorable price variance occurring (1) because of a request for rush order due to
poor scheduling or (2) when they specify certain brand-name materials or materials
of certain grade or quality other than those initially included in the bill of materials.
The possible causes of material quantity variance are as follows:

1. Waste and loss of material in handling and processing.
2. Substitution of defective or nonstandard materials.
30
3. Spoilage or production of excess scrap because of inexperienced workers or
poor supervision.
4. Lack of proper tools or machines.
5. Variation in yields from materials
Responsibility: Production line supervisors should be held responsible for materials

under their control.
Sample Problem 1: Direct Materials Variance

Glass Peak Outfitters has the following direct material standard for the fiberfill in its
mountain parka.0.1 kg. of fiberfill per parka at P5.00 per kg.
Last month 210 kgs of fiberfill were purchased and used to make 2,000 parkas. The
material cost a total of P1,029.
Materials price variance

MPV = AQ (AP - SP)
= 210 kgs (P4.90/kg - P5.00/kg)
= 210 kgs (-P0.10/kg)
= P21 F
Materials quantity variance

MQV = SP (AQ - SQ)
= P5.00/kg {210 kgs-(0.1 kg/parka 2,000 parkas)}
= P5.00/kg (210 kgs - 200 kgs)
= P5.00/kg (10 kgs)
= P50 U
When the manufacturing process uses several different direct materials that are
supposed to be combined in a standard proportion, the materials quantity may be
broken down into:
a. Materials Mix Variance – arises from the usage of materials in a proportion
different from standard.
b. Materials Yield Variance – arises when actual output differs from the quantity
of expected output.
Materials Mix Variance may be computed as follows:

Actual Quantity X Standard Price (per material) P XX
Less: Total Actual Input X Average Standard Price XX
Unfavorable (Favorable) P XX
Materials Yield Variance may be computed as follows:

Total Actual Input X Average Standard Price P XX
Less: Standard Quantity X Standard Price (per material) XX
31
Sample Problem 2: Materials Mix and Yield Variance
A company combines three types of materials to produce its product. for a 100-kilo
batch, the standard costs for materials are as follows:
Standard Quantity Standard Price Total
Material A 3,200 kgs. P5 P 300
Material B 2,350 kgs. 4 144
Material C 1,510 kgs. 3 72
Total Usage 7,060 kgs 516
During August, the company produced 200 batches or 20,000 kilos of its product.
materials used for this production were:
Quantity Price Total
Material A 12,600 kgs. P 4.80 P 69,480
Material B 7,300 kgs. 4.10 29,930
Material C 4,700 kgs. 3.40 15,980
Total Usage 24,600 kgs P 106,390
Material Mix Variance:

Actual Quantity Standard Price Total
Material A 12,600 kgs. X P5 P 63,000
Material B 7,300 kgs. X 4 29,200
Material C 4,700 kgs. X 3 14,100
Total 106,300
Less: Total Actual Input X Average Standard Price* (105,780)
Materials Mix Variance P520
Unfavorable
*(24,600 kgs X P4.30** = P 16,238)
**(P516/120 kgs. = P4.30)
The materials yield variance is computed as follows:

Total Actual Input X Average Standard Price P 105,780
Less: Standard Quantity Standard Price
Material A 12,000 X P5 P 60,000
(24,000x60/120)
Material B 7,200 X P4 28,800
(24,000x36/120)
32
Material C 4,800 X P3 14,400
(24,000x24/120)
Total 103,200
Materials Yield Variance P2,580
Unfavorable
6.2. Direct Labor Variance Analysis
Labor cost variance is the difference between actual labor cost and standard
labor cost. This variance may be analyzed into two components, namely, the
labor rate variance and labor efficiency variance.
• Labor Rate Variance (LRV)– is the difference between the actual labor rate
paid and the standard labor rate. This type of variance is the responsibility of
the personnel department. The formula is:
LRV = (Actual Rate – Standard Rate) * Actual Hours
• Labor Efficiency Variance (LEV) – is the difference between the actual

hours used and the standard hours allowed for actual production. This type of
variance is the responsibility of the production department. The formula is:
LEV = (Actual Hours - *Standard Hours Allowed) * Standard rate
Note: Standard Hours Allowed = (Actual production * SH required per unit of product)
If several different materials are used in the manufacturing process, the labor
efficiency variance may further be analyzed into:
a. Labor Efficiency Variance – the formula is:
Actual hours x Std. Rate P XX
Less: Std. Hours based on Actual Output x Std. Rate XX
b. Labor Yield Variance – a difference between the expected and the actual
quantities of output would also give rise to a variance in labor cost. The
formula is:
Std. Hours based on Actual Input x Std. Rate P XX
Less: Std. Hours based on Actual Output x Std. Rate XX
The possible causes of labor rate variance are as follows:

1. Inexperienced workers hired.
33
2. Change in labor rate particularly peak season that has not been incorporated
in standard rate.
3. Use of an employee having a wage classification other than that assumed
when the standard for a job was set.
4. Use of a greater number of higher paid employees in the group than
anticipated.
Responsibility: if production line supervisors have the authority to match workers
and machine to task by hiring the proper grade of labor, line supervisor should be
responsible. They will also be responsible if they control the wage rate of their labor
force. If they do not, the Personnel Department may be responsible.
The possible causes of labor efficiency variance are as follows:

1. Good or poor training of workers.
2. Poor materials or faulty equipment.
3. Good or poor supervision and scheduling of work.
4. Experience or lack of experience on the job.
Responsibility: Production line supervisors should be held responsible for labor

under their control.
Sample Problem 1: Direct Labor Variance
Glass Peak Outfitters has the following direct labor standard for its mountain
parka.1.2 standard hours per parka at P10.00 per hour
Last month employees actually worked 2,500 hours at a total labor cost of P26,250
to make 2,000 parkas.
Labor rate variance

LRV = AH (AR - SR)
= 2,500 hours (P10.50 per hour – P10.00 per hour)
= 2,500 hours (P0.50 per hour)
= P1,250 unfavorable
Labor efficiency variance

LEV = SR (AH - SH)
= P10.00 per hour (2,500 hours – 2,400 hours)
= P10.00 per hour (100 hours)
6.3. Factory Overhead Variance Analysis
Variable Manufacturing Overhead Variance Analysis
34
Total variable manufacturing overhead variance is the difference between actual
variable overhead and standard variable overhead allowed on actual output. This
may be broken down into:
a. Variable overhead spending variance
b. Variable overhead efficiency variance
These variances are computed as follows:
Variable Overhead Spending Variance

Actual Variable OH P XX
Less: Actual Hours * Standard variable OH rate XX
Unfavorable (Favorable) XX
Variable Overhead Efficiency Variance

Actual Hours P XX
Less: Standard Hours XX
Multiplied by: Standard variable OH rate XX
The possible causes of variable overhead spending or controllable variance

are as follows:
1. Increase in energy costs
2. Waste in using supplies
3. Avoidable machine breakdowns
4. Wrong grade of indirect material an indirect labor
5. Lack of operators or tools.
Responsibility: Supervisors of cost centers are responsible because they have

some degree of control over these budget or expense factors.
The possible cause of variable overhead efficiency variance is attributable to

efficiency in using the base on which variable overhead is applied.
Responsibility: Production line supervisors are responsible for this variance.

Fixed Manufacturing Overhead Variance Analysis
In variance analysis, fixed manufacturing costs are treated differently from variable
manufacturing costs. It is usually assumed that fixed costs are unchanged when
volume changes, so the amount budgeted for fixed overhead is the same in both the
master and flexible budgets. There is no input – output relationship for fixed
overhead.
a. Fixed spending variance – the difference between the actual fixed overhead
and the budgeted fixed overhead at normal capacity.
b. Volume variance – difference between the budgeted fixed overhead and
applied fixed overhead.
35
The possible causes of volume variance are as follows:
1. Poor production scheduling
2. Unusual machine breakdowns
3. Storms or strikes
4. Fluctuations over time
5. Excess plant capacity
Responsibility: Line supervisors can control fixed overhead when the costs are
discretionary rather than committed. Top sales executive may be held responsible if
budgeted volume is matched with anticipated long – run sales. Responsibility usually
rests with top management, for the volume variance represents under or over
utilization of plant and equipment.
Combined Manufacturing Overhead (Variable & Fixed) Variance Analysis
I. If the company is using a flexible budget, the total overhead variance may
be analyzed as follows:
A. Under the Two – Variance Method

Controllable variance
Actual Manufacturing Overhead P XX
Less: Budget allowed based on standard hours:
Fixed Costs (at normal capacity) P XX
Variable (SH*VOH rate) XX XX
Volume variance
Budget allowed based on standard hours P XX
Less: Standard Hours * Standard Overhead rate XX
TOTAL MANUFACTURING OVERHEAD VARIANCE P XXX
B. Under the Three – Variance Method

Spending variance
Less: Budget allowed based on actual hours:
Variable (AH*VOH rate) XX XX
Variable efficiency variance

Budget allowed based on actual hours P XX
Variable (SH*VOH rate) XX XX
36
Volume variance
C. Under the Four – Variance Method

Variable OH Spending variance
Actual Variable Manufacturing Overhead P XX
Variable (AH*VOH rate) XX
Variable OH efficiency variance

Budget allowed based on actual hours (variable) P XX
Variable (SH*VOH rate) XX
Fixed OHspending variance

Actual Fixed Manufacturing Overhead P XX
Less: Applied Fixed Manufacturing Overhead XX
Volume variance
II. If the company is using a static budget, the total overhead variance may be
analyzed as follows:
Budget variance
Less: Budgeted Overhead (at normal capacity) XX
Capacity variance
Budgeted Overhead P XX
Less: Standard or Applied Overhead
XX
(Standard hours * Standard overhead rate)
37

Budget variance
Less: Budgeted Overhead (at normal capacity) XX
Capacity variance
Budgeted hours * Standard overhead rate P XX
Less: Actual hours * Standard overhead rate
Efficiency variance
Actual hours * Standard overhead rate P XX
Sample Problem 1: Manufacturing Overhead Variance
Select Company uses a standard cost system for its production process and applies
overhead based on direct labor hours. The following information is available for July
when Select made 4,500 units:
Standard:
Direct Labor Hour per unit 2.50
Variable overhead per DLH P1.75
Fixed overhead per DLH P3.10
Budgeted variable overhead P21,875
Budgeted fixed overhead P38,750
Actual:
Direct labor hours 10,000
Variable overhead P26,250
Fixed overhead P38,000

Actual Manufacturing Overhead P 64,250.00
Fixed Costs (at normal capacity) P 38,750
Variable (SH*VOH rate) 19,687.50 58,437.50
Unfavorable P 5,812.50
38
Volume variance
Budget allowed based on standard hours P 58,437.50
Less: Standard Hours * Standard Overhead rate 54,562.50
TOTAL MANUFACTURING OVERHEAD VARIANCE P 9,687.50

Unfavorable
Note:
Actual Mfg. OH = P26,250 + 38,000
= 64,250.00
BABOSH (variable) = 4,500 units x 2.5 DLH x P1.75
= 19,687.50
Std. Mfg. OH = 4,500 units x 2.5 DLH x (P1.75 + P3.10)
= 54,562.50

Spending variance
Actual Manufacturing Overhead P 64,250.00
Variable (AH*VOH rate) 17,500 56,250.00
Unfavorable P 8,000

Budget allowed based on actual hours P 56,250.00
Less: Budget allowed based on standard
58,437.50
hours:
Favorable P (2,187.50)
Volume variance
Less: Standard Hours * Standard Overhead
54,562.50
rate
TOTAL MANUFACTURING OVERHEAD P 9,687.50

VARIANCE Unfavorable
Note:
BABOAH (variable) = 10,000 DLH x P1.75
= 19,687.50

Actual Variable Manufacturing Overhead P 26,250
39
Variable (AH*VOH rate) 17,500

Budget allowed based on actual hours (variable) P 17,500.00
Variable (SH*VOH rate) 19,687.50
Favorable P (2,187.50)
Fixed OH spending variance

Actual Fixed Manufacturing Overhead P 38,000.00
Less: Applied Fixed Manufacturing Overhead 38,750.00
Favorable P (750.00)
Volume variance
Less: Standard Hours * Standard Overhead rate 54,562.50
Unfavorable (Favorable) P 3,875.00
TOTAL MANUFACTURING OVERHEAD VARIANCE P 9,687.50

Unfavorable
ILLUSTRATIVE PROBLEM 1: VARIANCE ANALYSIS
The following events took place at Nova Containers, Inc. during the month of
November:
a. Produced and sold 50,000 plastic water containers at a sales price of P10
each. (budgeted sales were 45,000 units at P10.15)
b. Standard variable cost per unit:

Direct Materials: 2 lbs. @ P1.00 P 2.00
Direct Labor: 0.10 hours @ P15.00 1.50
Variable Manufacturing Overhead: 0.10 hours @ P5.00 0.50
P 4.00 per unit
c. Fixed manufacturing overhead cost:

Monthly budget (P20 per hour) P 80,000
Estimated monthly production - 40,000 units or 4,000 hours
d. Actual production costs

Direct Materials purchased: 200,000 lbs. @ P1.20 P 240,000
Direct Materials used: 110,000 lbs. @ P1.20 132,000
Direct Labor: 6,000 hours @ P14.00 84,000
Variable Manufacturing Overhead 28,000
Fixed Manufacturing Overhead 83,000
40
Required:
I. Compute the following:
a. Direct materials variance
b. Direct labor variance
c. Manufacturing overhead variance
Solution:
Direct materials variance

Materials Price Variance
Actual materials purchased P240,000
Less: Actual Quantity Purchased at Standard price:
200,000
(200,000 x P 1.00)
Unfavorable P 40,000
Materials Quantity Variance

Actual Quantity Used at Standard price:
P 110,000
(110,000 x P1.00)
Less; Standard quantity at Standard Price
100,000
(50,000 units x 2 lbs x P1.00)
TotalDirect Materials Variance P 50,000
Journal Entries:
Direct materials inventory 200,000

Materials price variance 40,000
Accounts Payable 240,000
Work in process inventory 100,000

Materials quantity variance 10,000
Direct materials inventory 110,000
Direct labor variance

Labor rate Variance
Actual labor costs P84,000
Less: Actual hours at Standard rate:
90,000
(6,000 x P 15.00)
Favorable P (6,000)
Labor Efficiency Variance

Actual hours at Standard rate:
P 90,000
(6,000 x P 15.00)
41
Less; Standard hours at Standard rate
75,000
(50,000 units x 0.10hrs. x P15.00)
TotalDirect LaborVariance P 9,000
Journal Entries:

Labor efficiency variance 15,000
Labor rate variance 6,000
Accrued Payroll 84,000

Actual Manufacturing Overhead P 111,000
hours:
Variable (SH*VOH rate) 25,000 105,000
Unfavorable P 6,000
Volume variance
Budget allowed based on standard hours P 105,000
125,000
rate
Favorable P (20,000)
TOTAL MANUFACTURING OVERHEAD P

VARIANCE 14,000Favorable
Spending variance
Actual Manufacturing Overhead P 111,000
Less: Budget allowed based on actual
hours:
Variable (AH*VOH rate) 30,000 110,000
Unfavorable P 1,000

Budget allowed based on actual hours P 110,000
105,000
hours:
Unfavorable P 5,000
Volume variance
125,000
rate
42
TOTAL MANUFACTURING OVERHEAD P 14,000

VARIANCE Favorable

Actual Variable Manufacturing Overhead P 28,000
Variable (AH*VOH rate) 30,000
Favorable P (2,000)

Budget allowed based on actual hours (variable) P 30,000
Variable (SH*VOH rate) 25,000
Unfavorable P 5,000
Fixed OH spending variance

Actual Fixed Manufacturing Overhead P 83,000.00
Less: Applied Fixed Manufacturing Overhead 80,000.00
Unfavorable P 3,000
Volume variance
Less: Standard Hours * Standard Overhead rate 125,000
TOTAL MANUFACTURING OVERHEAD VARIANCE P 14,000

Favorable
Journal Entries:

Variable overhead applied 25,000
Variable overhead actual 28,000

Miscellaneous Accounts 28,000
Variable overhead applied 25,000

Variable overhead efficiency variance 5,000
Variable overhead spending variance 2,000
Variable overhead actual 28,000
43
Fixed overhead applied 100,000
Fixed overhead actual 83,000

Miscellaneous Accounts 83,000
Fixed overhead applied 100,000

Fixed overhead spending variance 3,000
Fixed overhead production volume variance 20,000
Fixed overhead actual 83,000
Let’s Check!
I. Questions:
1. “Cost control means cost reduction.” Do you agree?

________________________________________________________
________________________________________________________
________________________________________________________
2. Why separate price and quantity variances?

________________________________________________________
________________________________________________________
________________________________________________________
3. What is meant by the term variance?

________________________________________________________
________________________________________________________
________________________________________________________
II. Multiple Choice:

1. The best characteristics of a standard cost system is

a) standard can pinpoint responsibility and help motivation
b) all variances from standard should be reviewed
c) all significant unfavorable variances should be reviewed
d) standard cost involves cost control which is cost reduction
2. Standard costs are used for all of the following except:

a) income determination
b) measuring efficiencies
c) controlling costs
d) forming a basis for price setting
44
3. Standard costs are least useful for
a) Measuring production efficiency
b) Job order production systems
c) Simplifying costing procedures
d) Determining minimum inventory levels
4. A difference between standard costs used for cost control and budgeted
costs
a) Can exist because standard costs must be determined after the
budget is completed.
b) Can exist because standard costs represent what costs should be
while budgeted costs represent expected actual costs.
c) Can exist because budgeted costs are historical costs while
standard costs are based on engineering studies.
d) Can exist because establishing budgeted costs involves employee
participation and standard costs do not.
5. Normal costing and standard costing differ in that

a) the two systems can show different overhead budget variances.
b) only normal costing can be used with absorption costing.
c) the two systems show different volume variances if standard hours
do not equal actual hours.
d) normal costing is less appropriate for multiproduct firms
6. KNOTTY, Inc. estimated the cost of a project it started in October 19x4 as

follows: Direct materials, P495,000; direct labor, 6,000 hours at P30 per
hour; variable overhead, P24 per direct labor hour. By the end of the
month, all the required materials have been used at P491,900; labor was
80% complete at 4,650 hours at P30 per hour; and, the variable overhead
amounted to P113,700. The total variance for the project as at the end of
the month was
a) P7,500 U c) P9,000 F
b) P8,400 U d) P9,00 F
7. ALPHA Co. uses a standard cost system. Direct materials statistics for the
month of May, 2020 are summarize below:
Standard unit price P90.00
Actual units purchased 40,000
Standard units allowed for actual production 36,250
Materials price variance- favorable P6,000
What was the actual purchase price per unit?
a) P75.00 c) P88.50
b) P85.89 d) P89.85
8. JKL Company has a standard of 15 parts of component X costing P1.50

each. JKL purchased 14,910 units of component X for P22,145. JKL
generated a P220 favorable price variance and a P3,735 favorable
45
quantity variance. If there were no changes in the component inventory,
how many units of finished product were produced?
a) 994 units.
b) 1,090 units.
c) 1,000 units
d) 1,160 units
9. ACE Company’s operations for the month just ended originally set up a
60,000 direct labor hour level, with budgeted direct labor of P960,000 and
budgeted variable overhead of P240,000. The actual results revealed that
direct labor incurred amounted to P1,148,000 and that the unfavorable
variable overhead variance was P40,000. Labor trouble caused an
unfavorable labor efficiency variance of P120,000, and new employees
hired at higher rates resulted in an actual average wage rate of P16.40 per
hour. The total number of standard direct labor hours allowed for the
actual units produced is
a) P52,500
b) P60,000
c) P62,500
d) P70,000
10. ABC Company uses the equation P300,000 + P1.75 per direct labor hour
to budget manufacturing overhead. ABC has budgeted 125,000 direct
labor hours for the year. Actual results were 110,000 direct labor hours,
P297,000 fixed overhead, and P194,500 variable overhead. What is the
fixed overhead volume variance for the year?
a) P35,000 U.
b) P36,000 U.
c) P2,000 F
d) P3,000 F
Let’s Analyze!
Monde Mills Company is a large producer of men’s and women’s clothing. The
company uses standard costs for all of its products. The standard costs and actual
costs for a recent period are given below for one of the company’s product lines (per
unit of product):
Standard Actual
Cost Cost
Direct materials:
Standard: 4.0 yards at P3.60 per yard P 14.40
Actual: 4.4 yards at P3.35 per yard P14.74
Direct labor:
Standard: 1.6 hours at P4.50 per hour 7.20
Actual: 1.4 hours at P4.85 per hour 6.79
46
Variable manufacturing overhead:
Standard: 1.6 hours at P1.80 per hour 2.88
Actual: 1.4 hours at P2.15 per hour 3.01
Total cost per unit P 24.48 P 24.54
During the period, the company produced 4,800 units of product. a comparison of
standard and actual costs for the period on a total cost basis is shown below:
Actual costs: 4,800 units at P24.54 P 117,792

Standard costs : 4,800 units at P24.48 117,504
Difference in costs – unfavorable P 288
There was no inventory of materials on hand to start the period. During the period,
21,120 yards of materials were purchased, all which were used in production.
Required:
I. For direct materials:
a. Compute the price and quantity variances for the period.
b. Prepare journal entries to record all activity relating to direct
materials for the period.
II. For direct labor:

a. Compute the rate and efficiency variances.
b. Prepare a journal entry to record the incurrence of direct labor for
the period.
III. Compute the variable manufacturing overhead spending and efficiency

variances.
IV. On seeing the P288 total cost variance, the company’s president stated.
“This variance of P288 is only 0.2% of the P117,504 standard cost for the
period. It’s obvious that our costs are well under control.” Do you agree?
Explain.
V. State possible causes of each that you have computed.
In a Nutshell
Tim Zeff is a plant manager who has done a good job of controlling some overhead
costs during the current period and a poor job of controlling others. Tim’s boss has
asked him for a variance report for the period.Discuss the ethics of using a two-
variance approach to report the overhead variances rather than a three- or four-
variance approach.
47
Q&A List
1.
2.
3.
4.
5.
Keywords index
Standard costs Yield variance
Price variance Manufacturing overhead variances
Quantity variance Standard hours allowed
Mix variance Standard rate
Self-help
lesson:

Co., Inc.
Big Picture
Week 6&7: Unit Learning Outcomes (ULO): At the end of the unit, you are expected
to:
a. explain the concept of variable and absorption costing.
b. describe the concept and importance ofcost-volume-profit relationship in the
operation of the business.
48
Big Picture in Focus: ULOa.explain the concept of variable and absorption
costing
Metalanguage
1. Absorption costing – (also known as full costing) is an approach to product
costing that assigns all manufacturing costs (direct materials, direct labor and
all factory overhead) to the items produced. Thus, inventoriable cost include
all the cost elements of production; and period include all non-manufacturing
costs. This method is typically used for external income statement reporting.
2. Variable costing –(also known as direct costing) is an approach to product

costing that assigns only variable manufacturing costs (direct materials, direct
labor and variable factory overhead) to the items produced. Thus,
inventoriable cost are limited to the variable manufacturing costs; and period
include all fixed costs and variable non-manufacturing costs. This method is
typically used for internal income statement reporting.
Essential Knowledge
This portion discusses the cost accumulation and presentation techniques to product
costing. Cost accumulation and presentation procedures are accomplished using
one of two methods: absorption costing or variable costing. Each method uses the
same basic data, but structures and processes the data differently.
1. Product Cost Components
Absorption Costing Variable Costing

Direct materials Direct materials
+ Direct labor + Direct labor
+ Variable FOH + Variable FOH
+ Fixed FOH -
Product Cost Product Cost
2. Distinction between Period costs and Product costs
Period Cost Product Cost

1. Cost that is charged against 1. Cost that is included in the
current revenue during a time computation of product cost
period regardless of the that is apportioned between the
49
difference between production sold and unsold units.
and sales volumes.
2. Does not form part of the cost of 2. An inventoriable cost. The
inventory. portion of the cost that has been
allocated to the unsold units
becomes part of the cost of
inventory.
3. Reduces income for the current 3. Reduces current income by the
period by its full amount. portion allocated to the sold
units; the portion allocated to
unsold units is treated as an
asset, being part of the cost of
inventory.
3. Principal differences between Absorption and Variable Costing Method

1. Cost segregation Seldom segregates costs Costs are segregated into
into variable and fixed variable and fixed
costs
2. Cost of inventory Cost of inventory includes Cost of inventory includes
all the manufacturing only the variable
costs: materials, labor, manufacturing costs:
variable factory overhead, materials, labor, and
and fixed factory variable factory overhead
overhead
3. Treatment of fixed Fixed factory overhead is Fixed factory overhead is
factory overhead treated as product cost treated as period cost
4. Income Statement Distinguishes between Distinguishes between
production and other variable and fixd costs.
costs. Sales XX
Sales XX -Variable costs XX
-COGS (production XX Contr. margin XX
costs) -Fixed costs XX
Gross Profit XX Profit XX
-S&A costs XX
Profit XX
5. Net Income Net income between the two methods may differ from
each other because of the difference in the amount of
fixed overhead costs recognized as expense during
an accounting period. This is due to variations
between sales and production. In the long run,
however, both methods give substantially the same
results since sales cannot continuously exceed
production, nor production can continually exceed
50
sales.
4. Difference in Net Income under Absorption and Variable Costing
Variable and absorption costing methods of accounting for fixed manufacturing

overhead result in different levels of net income in most cases. The differences are
timing differences, i.e., when to recognize the fixed manufacturing overhead as an
expense. In variable costing, it is expensed during the period when the fixed
manufacturing overhead is incurred, while in absorption costing, it is expensed in the
period when the units to which such fixed manufacturing overhead are sold.
▪ Production equals Sales

When production is equals to sales, there is no change in inventory.
Fixed overhead expensed under absorption costing equals fixed
overhead expensed under variable costing. Therefore, absorption
costing income equals variable costing income.
▪ Production is greater than Sales

When production is greater than sales, there is an increase in
inventory. Fixed overhead expensed under absorption costing is less
than fixed overhead expensed under variable costing. Therefore,
absorption costing income is greater than variable costing income.
▪ Production is less than Sales

When production is less than sales, there is an decrease in inventory.
Fixed overhead expensed under absorption costing is greater than
fixed overhead expensed under variable costing. Therefore, absorption
costing income is less than variable costing income.
5. Reconciliation of Absorption and Variable Costing Income Figures
Absorption costing income P XX

Add: Fixed overhead in the beginning inventory XX
Total XX
Less: Fixed overhead in the ending inventory XX
Variable costing income P XX
6. Accounting for Difference in Income
Change in inventory (production less sales) P XX

Multiple by: FOH cost per unit XX
Difference in income P XX
7. Arguments for the use of Variable costing

1) Variable costing reports are simpler and more understandable.
2) Data needed for break-even and cost-volume-profit analyses ae readily
available.
51
3) The problems involved in allocating fixed costs are eliminated.
4) Variable costing is more compatible with standard cost accounting system.
5) Variable costing reports provide useful information for pricing decisions and
other decision – making problems encountered by management.
8. Arguments against Variable costing

1) Segregation of costs into fixed and variable might be difficult, particular in the
case of mixed costs.
2) The matching principle is violated by using variable costing which excludes
fixed overhead from product costs and charges the same to period costs
regardless of production and sales.
3) With variable costing, inventory costs and other elated accounts, such as
working capital, current ratio, and acid test ratio are understated because of
the exclusion of fixed overhead in the computation of product cost.
Sample problem:
During the year 2020, Clove Corporation’s production was equal to its normal
capacity of 1,000 units. It sold 900 units at a price of P50 per unit.
The following costs were incurred during the year:

Total Cost Cost per unit
Direct materials P 12,000 P12
Direct labor 10,000 10
Variable factory overhead 8,000 8
Fixed factory overhead 6,000 6
Variable selling & administrative 4,500 5*
Fixed selling & administrative 3,000 3
*variable selling &adm. cost per unit = P4,500 ÷ 900 = P5.
I. Product cost per unit

Product cost per unit
Direct materials P 12 P 12
Direct labor 10 10
Variable factory overhead 8 8
Fixed factory overhead 6 -
Product cost per unit P 36 P 30
II. Income under absorption costing

Sales (900 units x P50) P 45,000
Less: Cost of goods sold (900 units x
32,400
P36)
Gross Profit 12,600
Less: selling & administrative expenses
52
Variable (900 x P5) P 4,500
Fixed 3,000 7,500
Income P 5,100
III. Income under variable costing

Sales (900 units x P50) P 45,000
Less: Variable costs
Cost of goods sold (900 x P30) P 27,000
selling & administrative expenses 4,500 31,500
Contribution Margin 13,500
Less: Fixed costs
Factory overhead 6,000
selling & administrative expenses 3,000 9,000
Income P 4,500
IV. Computation of and accounting for the difference in income

Absorption costing income P5,100
Variable costing income 4,500
Difference in income P 600
Let’s Check!
I. Questions:
1. “The central issue in variable costing is timing.” Explain.

________________________________________________________
________________________________________________________
________________________________________________________
2. Why is direct costing a misnomer? Explain

________________________________________________________
________________________________________________________
________________________________________________________
3. Under absorption costing, how is it possible to increase net operating

income without increasing sales?
________________________________________________________
________________________________________________________
________________________________________________________
II. True or False

1. The inventory value shown on the balance sheet is generally higher

under absorption costing than under variable costing.
53
2. Under variable costing, inventoriable product costs consist of direct
materials, direct labor, variable manufacturing overhead and variable
selling and administration expenses.
3. Under variable costing, an increase in the fixed factory overhead will
have no effect on the unit product cost.
4. Under the absorption costing method, a portion of fixed manufacturing
overhead cost is allocated to each unit of product.
5. Under variable costing, it is possible to defer a portion of the fixed
manufacturing overhead costs of the current period to future periods
through the inventory account.

1. To apply variable costing method it is necessary that you know

a. Standard production rate and times of production elements
b. Contribution margin and break even point in production
c. Variable and fixed cost related to production
d. Controllable and uncontrollable cost of production
2. The following statements about the adoption of variable costing are true,
except:
a. All fixed manufacturing costs are recognized as period costs.
b. A direct cost may not become a product cost.
c. It is an acceptable method for general reporting purposes.
d. An indirect cost may be assigned as part of product cost.
3. The change in period-to-period operating income when using variable costing

can be explained by the change in the
a. Unit sales level multiplied by the unit sales price.
b. Finished goods inventory level multiplied by the unit sales price.
c. Unit sales level multiplied by a constant unit contribution margin.
d. Finished goods inventory level multiplied by a constant unit contribution
margin.
4. Which of the following is NOT an advantage of using variable costing for

internal reporting purposes?
a. Fixed costs are reported at incurred values, not absorbed values, thus
improving control over those costs.
b. Profits are directly influenced by changes in sales volume.
c. The impact of fixed costs on profits is emphasized.
d. Total costs may be overlooked when evaluating profits.
5. Under absorption costing, fixed manufacturing overhead could be found in all

of the following except the
a. work-in-process account.
b. Cost of Goods Sold.
c. finished goods inventory account.
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d. period costs.
6. MNO Products, Inc. planned and actually manufactured 200,000 units of its
single product in 2000, its first year of operations. Variable manufacturing
costs were P30 per unit of product. Planned and actual fixed manufacturing
costs were P600,000, and marketing and administrative costs totaled
P400,000 in 2000. MNO sold 120,000 units of product in 2000 at a selling
price of P40 per unit. What is the cost of the ending inventory assuming
variable costing is used?
a. P2,250,000 c. P2,640,000
b. P2,400,000 d. P2,700,000
7. The total production cost for 20,000 units was P21,000 and the total
production cost for making 50,000 units was P34,000. Once production
exceeds 25,000 units, additional fixed costs of P4,000 were incurred. The full
production cost per unit for making 30,000 units is:
a. P0.30 c. P0.84
b. P0.68 d. P0.93
8. GHI Company had P100,000 income using absorption costing. GHI has no
variable manufacturing costs. Beginning inventory was P5,000 and ending
inventory was P12,000. What is the income under variable costing?
a. P107,000. c. P93,000
b. P100,000 d. P88,000
9. A company had an income of P50,000 using direct costing for a given month.
Beginning and ending inventories for the month are 13,000 units and 18,000
units, respectively. Ignoring income tax, if the fixed overhead application rate
was P2 per unit, what was the income using absorption costing?
a. P40,000 c. P60,000
b. P50,000 d. P70,000
10. At the end of Killo Co.’s first year of operations, 1,000 units of inventory
remained on hand. Variable and fixed manufacturing cost per unit were P90
and P20, respectively. If Killo uses absorption costing rather than direct
(variable) costing, the result would be a higher pretax income of
a. P0. c. P70,000.
b. P20,000. d. P90,000.
Let’s Analyze!
The Casper Company is comparing its present absorption costing practices with
direct costing methods. An examination of its records produced the following
information:
Maximum plant capacity 40,000 units
Normal capacity 36,000 units
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Fixed factory overhead P 54,000

Fixed marketing and administrative expense P 20,000
Sales price per unit P 10
Standard variable manufacturing cost per unit P4
Variable marketing expense per unit sold P1
For the year, the following data are available:

Budgeted production 36,000 units
Actual production 30,000 units
Sales 28,000 units
Finished goods inventory, beginning P 1,000
Unfavorable variances from standard variable P 5,000
manufacturing costs
All variances are written off directly at year-end as an adjustment in Cost of Goods
Sold.
Required:
1) Prepare the income statement under the direct costing method.
2) Prepare the income statement under the absorption costing method.
In a Nutshell
A significant difference between absorption costing and variable costing centers
around the debate of whether fixed manufacturing overhead is justified as a product
cost. Because your professor is scheduled to address a national professional
meeting at the same time your class would ordinarily meet, the class has been
divided into teams to confront selected issues. Your team’s assignment is to prepare
a report arguing both sides of the issue stated above. You are also expected as a
team to draw your own conclusion and so state it in your report along with the basis
for your conclusion
Q&A List
1.
2.
3.
4.
5.
Keywords index
56
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Variable costing Absorption costing

Contribution margin Net profit
Fixed costs Variable costs
Self-help
lesson:
Co., Inc.
Big Picture in Focus: ULOb.describe the concept and importance of cost-

volume-profit relationship in the operation of the business.
Metalanguage
1. Cost – volume – profit relationship - is an analysis which examines the
relationships between the sales, costs and expenses, and quantity, and its
impact on the amount of profits.
Essential Knowledge
To perform the aforesaid big picture (unit learning outcomes) for the first two (2)
weeks of the course, you need to fully understand the following essential knowledge
that will be laid down in the succeeding pages. Please note that you are not limited
to exclusively refer to these resources. Thus, you are expected to utilize other books,
research articles and other resources that are available in the university’s library e.g.
ebrary, search.proquest.com etc.
1. Cost – Volume – Profit (CVP)analysis examines the interaction of a firm’s sales

volume, selling price, cost structure, and profitability. It is a powerful tool in
making managerial decisions including marketing, production, investment, and
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financing decisions. Here are the common questions that usually managers
address.
 How many units of its products must a firm sell to break even?
 How many units of its products must a firm sell to earn a certain amount of
profit?
 Should a firm invest in highly automated machinery and reduce its labor
force?
 Should a firm advertise more to improve its sales?
CVP analysis is the systematics examination of the interrelationship among

revenues, variable costs, fixed costs, activity levels or volume and profit. It permits
management to predict the probable effects of changes in sales price, sales volume,
costs and product mix.
1.1. Elements of CVP Analysis

1. Sales
a. Selling price
b. Units or volume
2. Total fixed costs
3. Variable per unit
4. Sales mix (for multiple products)
1.2. Application of CVP Analysis

Planning and decision – making, which may involve choosing the:
1. Type of product to produce and sell
2. Pricing policy to follow
3. Marketing strategy to use
4. Type of productive facilities to acquire
1.3. The Contribution Margin Income Statement

The costs and expenses in the Contribution Margin Income Statement are
classified as to behavior (variable and fixed). The amount of contribution margin
is the difference between sales and variable costs. The format is as follows:
CONTRIBUTION MARGIN INCOME STATEMENT
Sales (units * selling price) P XX

Less: Variable Costs (units * variable cost per unit) XX
Contribution Margin XX
Less: Fixed Costs XX
Income before Tax (Operating Profit) P XX
The contribution margin income statement is prepared for management own use.
The format facilitates cost-volume-profit analysis. Contribution margin is the
amount available for the recovery of fixed cost and generation of profit.
1.4. Assumptions of CVP Analysis

✓ All costs are classified as either variable and fixed.
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✓ Cost and revenue relationship are predictable and linear over a relevant
range of activity and a specified period of time.
✓ Total variable costs change directly with the cost driver, but variable cost
per unit are constant over the relevant range.
✓ Total fixed costs are constant over the relevant range, but fixed cost per
unit vary inversely with the cost driver or volume.
✓ Selling prices per unit and market conditions remain unchanged.
✓ Production equals sales. (i.e., there is no change in inventory)
✓ If the company sells multiple products, sales mix is constant.
✓ Technology, as well as productive efficiency, is constant.
✓ The time value of money is ignored.
1.5. CVP Graph
1.6. Factors that affect Profit
Profit is the excess of total revenue over the total costs and expenses incurred in
generating such revenue during accounting period. Several factors affect profit.
They are:
1. Selling prices of products
2. The number of units sold (quantity)
3. The unit variable costs
4. The total fixed costs
5. The mix or combination of products sold
All these factors should be considered in profit planning. Cost – volume – profit
analysis shows the relationship between these variables which form the basis for
profit planning.
2. THE BREAK-EVEN ANALYSIS
Break-even point (BEP) is the level of activity or volume of operations where the
total revenue and total costs are in equilibrium. It is the point at which the business
entity neither makes a profit nor sustains a loss.
A. Single product break-even.
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The basic formula are:

Total Fixed Costs
BEP in units =
Contribution margin per unit
Total Fixed Costs

BEP in pesos =
Contribution margin ratio
Other Formulas:
Contribution margin = Sales – Variable costs
Contribution margin per unit = Selling price – Variable costs per unit
Contribution margin ration = Contribution margin ÷ Sales
Sample problem:
Consider the following data:
Sales (10,000 units @ P10) P 100,000
Variable costs (10,000 units @ P6) 60,000
Contribution Margin (10,000 units @ P4) 40,000
Fixed costs 30,000
Profit P 10,000
The break-even point in units is:

FC P30,000
BEP in units = = = 7,500 units
CM/unit P4
*CM/unit = SP – VC per unit = P10 – 6 = P4
The break-even point in pesos is:
FC P30,000
BEP in pesos = = = P 75,000
CM ratio 40%
*CM ratio = CM ÷Sales = P40,000÷ P100,000 = 40%
B. Multiple product break-even.

Here are the necessary steps to perform in computing break-even for businesses
with multiple products.
I. Determine the weighted average contribution margin per sale or

contribution margin per mix. The formula is:
Product A Product B Product C
Sales price xxx xxx xxx
Less: Variable
xxx xxx xxx
cost/unit
CM per unit xxx xxx xxx
Multiply: Sales mix
xxx xxx xxx
ratio
Weighted Average CM xxx xxx xxx
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II. Determine the sales (or mixes) to break-even.
BEP in units Total Fixed Costs

=
(allproducts) Weighted Average Contribution margin per unit
BEP in pesos Total Fixed Costs

=
(all products) Weighted Average Contribution margin ratio
III. Determine the individual break-even point in units, by multiplying the

sales mix ratio to the number of sales; and the individual break-even
point in pesos by multiplying the individual break-even point in units to
the selling prices.
BEP in Sales mix BEP Sales BEP
Products units (all X = X =
products ratio (units) price (pesos)
A xxx xxx xxx xxx xxx
B xxx xxx xxx xxx xxx
C xxx xxx xxx xxx xxx
XXX
Sample problem:
A company sells Products A, B, and C. data about the three products are as follows:
PRODUCTS
TOTAL
A B C
Selling price P100 P120 P50
Variable cost per unit 60 90 40
CM per unit P40 P30 P10
Sales in units 1,000 2,000 5,000 8,000

Total fixed costs P101,680
1) Computation of weighted average contribution margin.

PRODUCTS
TOTAL
A B C
Sales (units*SP) P100,000 P240,000 P250,000 P590,000
Variable costs (units*VC/u) 60,000 180,000 200,000 440,000
Contribution margin 40,000 60,000 50,000 150,000
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WaCM ratio = Total CM ÷ Total Sales = P150,000 ÷ P590,000 = 25.42%
Note: For the purpose of computing the WaCM ratio, the sales mix ratio is
determined using the sales volume in pesos.
PRODUCTS
TOTAL
A B C
CM per unit P40 P30 P10
Multiply: Sales mix ratio 12.5% 25% 62.5%
WaCM per unit P5 P 7.50 P 6.25 P18.75
*1,000÷8,000=12.5% **2,000÷8,000=25% ***5,000÷8,000=62.5%
Note: For the purpose of computing the WaCMper unit, the sales mix ratio is
determined using the sales volume in units.
2) The company’s break-even point:

FC P101,680
BEP in units = = = 5,423 units
WaCM/unit P 18.75
FC P101,680
BEP in pesos = = = P 400,000
WaCM ratio 25.42%
3) The individual break-even point in units and in pesos:

BEP in Sales mix BEP Sales BEP
Products units (all X = X =
products ratio (units) price (pesos)
A 5,423 12.5% 678 P100 P67,800
B 5,423 25% 1,356 P120 162,720
C 5,423 62.5% 3,389 P50 169,450
5,423 P399,970
Difference due to rounding off
3. REQUIRED SALES WITH DESIRED PROFIT
The break-even formula may be expanded to compute the required sales (in units
and in pesos) to earn a desired amount of profit. For profit planning purposes, sales
with desired profit in units and pesos can also be determined using the following
formulas:
Required Sales in units Required Sales in pesos
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A. Single product
1. To earn a desired TFC + DP TFC + DP
amount of profit before RSu = RSP =
tax CM per unit CM ratio
2. To earn a desired NP NP
TFC + TFC +
amount of profit after RSu = 1 - TR RSP = 1 - TR
tax CM per unit CM ratio
B. Multiple products
1. To earn a desired TFC + DP TFC + DP
amount of profit before RSu = RSP =
tax WaCM per unit WaCM ratio
2. To earn a desired NP NP
TFC + TFC +
amount of profit after RSu = 1 - TR RSP = 1 - TR
tax WaCM per unit WaCM ratio
Where:
RSu = required sales in units
RSp = required sales in pesos
TFC= total fixed costs
DP = desired profit before tax
NP = desired profit after tax
CM = contribution margin
TR = tax rate
WaCM = weighted average contribution margin
Sample problem:
Macky, Inc., sells a single product for P10. Variable costs are P4 per unit and fixed
costs total P120,000 at a volume level of 10,000 units. The management would like
to earn a target profit before tax of P240,000?
a. Required sales in units:

RSu = (TFC + DP) ÷CM per unit
= (P120,000 + P240,000) ÷ (P10 – P4)
= P360,000 ÷ P6
= 60,000 units
b. Required sales in pesos:

RSp = (TFC + DP) ÷CM ratio
= (P120,000 + P240,000) ÷ (P6 ÷ P10)
= P360,000 ÷ 60%
= P600,000
4. THE MARGIN OF SAFETY
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Margin of safety indicates the amount or level of sales by which actual or planed
sales may be reduced without incurring a loss. Also, it is the amount of peso-sales or
number of units by which actual or budgeted sales may be decreased without
resulting into a loss. Here are the basic formula for determining margin of safety:
MSP = SP – BEPP
MSP
MSU = SU - BEPU OR MSU =
SP
MSP MSU
MSR = OR MSR =
SP SU
Where:
MSP = margin of safety in pesos
MSU = margin of safety in units
MSR = margin of safety ratio
SP = sales in pesos
SU = sales in units
SP = selling price
BEPP = break-even point in pesos
BEPU = break-even point in units
Sample problem:
If a company’s present sales is 100,000 units (or P500,000, because the selling price
is P5), and the break-even point is 60,000 units (or P300,000).
1. Margin of safety in pesos:

MSP = SP – BEPP
= P500,000 – P300,000 = P200,000
2. Margin of safety in units:

MSU = SU - BEPU
= 100,000 units – 60,000 units = 40,000 units
MSU = MSP ÷ SP
= P200,000 ÷ P5 = 40,000 units
3. Margin of safety ratio:

MSR = MSP ÷ SP
= P200,000 ÷ P500,000 = 40%
MSR = MSU ÷ SU
= 40,000 ÷ 100,000 = 40%
The company can reduce its present sales of P500,000 by P200,000 or by 40,000
units or 40%, without incurring loss.
5. THE OPERATING LEVERAGE
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Operating leverage measures the effect that a percentage change in sales revenue
has on pretax profit (income before tax). It is a principle by which management in a
high fixed cost industry with a relatively high contribution margin ratio (low variable
costs relative to sales revenue) can increase profits substantially with a small
increase in sales volume. This measure us typically called the operating leverage or
the degree of operating leverage, and it is computed as follows:
Contribution margin
Degree of Operating Leverage (DOL) =
Income before tax
As pretax profit moves closer to zero, the closer the company is to the breakeven point.
This will yield a high degree of operating leverage. As sales volume increases, the
contribution margin and pretax profit both increases, and consequently, the degree of
operating leverage becomes progressively smaller. Hence, the degree of operating
leverage is related to the distance between the break-even point and an actual or planned
sales volume. With an increase in sales volume, income will increase by the percentage
increase in sales volume multiplied by the degree of operating leverage.
Sample problem
Following is the company’s result of operation from its present sales level of
10,000 units:
Sales (10,000 units @ P5) P 50,000
Variable costs (10,000 units @ P3) 30,000
Contribution margin 20,000
Fixed costs 12,000
Income before tax P 8,000
The company’s degree of operating leverage:

Contribution margin
DOL =
Income before tax
P 20,000
DOL = = 2.5
P 8,000
Let’s Check!
I. Questions:
1. What is the meaning of the term contribution margin?
________________________________________________________
________________________________________________________
________________________________________________________
2. What is meant by the term operating leverage?

________________________________________________________
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________________________________________________________
________________________________________________________
3. What is meant by margin of safety?

________________________________________________________
________________________________________________________
________________________________________________________
II. True or False:

_____ 1. Operating leverage determines how income from

operations is to be divided between debt holders and
stockholders.
_____ 2. Contribution margin is equal to fixed costs minus variable
costs.
_____ 3. A lower price for the firm's product will reduce the firm's
breakeven point.
_____ 4. Linear breakeven analysis and operating leverage are only
valid within a relevant range of production.
_____ 5. Operating leverage emphasizes the impact of using fixed
assets in the business.

1) Cost-volume-profit analysis is a technique available to management to

understand better the interrelationships of several factors that affect a firm's
profit. As with many such techniques, the accountant oversimplifies the real
world by making assumptions. Which of the following is not a major
assumption underlying CVP analysis?
a. All costs incurred by a firm can be separated into their fixed and
variable components.
b. The product selling price per unit is constant at all volume levels.
c. Operating efficiency and employee productivity are constant at all
volume levels.
d. For multi-product situations, the sales mix can vary at all volume
levels.
2) CVP analysis relies on the assumptions that costs are either strictly fixed or
strictly variable. Consistent with these assumptions, as volume decreases
total
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a. fixed costs decrease.

b. variable costs remain constant.
c. costs decrease.
d. costs remain constant.
3) Cost-volume-profit relationships that are curvilinear may be analyzed linearly

by considering only
a. fixed and mixed costs.
b. relevant fixed costs.
c. relevant variable costs.
d. a relevant range of volume.
4) The margin of safety would be negative if a company('s)

a. was presently operating at a volume that is below the break-even
point.
b. present fixed costs were less than its contribution margin.
c. variable costs exceeded its fixed costs.
d. degree of operating leverage is greater than 100.
5) A recent income statement of Fox Corporation reported the following data:

Sales revenue P3,600,000
Variable costs 1,600,000
Fixed costs 1,000,000
If these data are based on the sale of 10,000 units, the break-even pointwould
be:
a. 2,000 units. c. 3,600 units.
b. 2,778 units. d. 5,000 units.
6) Maxie's budget for the upcoming year revealed the following figures:
Sales revenue P840,000
Contribution margin 504,000
Net income 54,000
If the company's break-even sales total P750,000, Maxie's safety margin

would be:
a. P(90,000). c. P246,000.
b. P90,000. d. P(246,000).
7) An organization's break-even point is 4,000 units at a sales price of P50 per

unit, variable cost of P30 per unit, and total fixed costs of P80,000. If the
company sells 500 additional units, by how much will its profit increase?
a. P25,000 c. P12,000
b. P15,000 d. P10,000
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8) O'Dell sells three products: R, S, and T. Budgeted information for the

upcoming accounting period follows.
Product Sales Volume (Units) Selling Price Variable
Cost
R 16,000 $14 $9
S 12,000 10 6
T 52,000 11 8
The company's weighted-average unit contribution margin is:

a. $3.00. c. $4.00.
b. $3.55. d. $19.35.
9) The following information relates to Day Company:

Sales revenue P12,000,000
Contribution margin 4,800,000
Net income 800,000
Day's operating leverage factor is:
a. 0.167.
b. 0.400.
c. 2.500.
d. 6.000.
Let’s Analyze!
Pullman Company is a small but growing manufacturer of telecommunications

equipment. The company has no sales force of its own; rather, it relies completely
on independent sales agents to market its products. These agents are paid a
commission of 15% of selling price for all items sold.
Maui Soliman, Pullman’s controller, has just prepared the company’s budgeted
income statement for next year. The statement follows:
Pullman Company
Budgeted Income Statement
For the Year Ended December 31
Sales P16,000,000
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Manufacturing costs:
Variable P7,200,000
Fixed overhead 2,340,000 9,540,000
Gross margin 6,460,000
Selling and administrative
costs:
Commissions to agents 2,400,000
Fixed marketing costs* 120,000
Fixed administrative costs 1,800,000 4,320,000
Net operating income 2,140,000
Less fixed interest cost 540,000
Income before income 1,600,000
taxes
Less income tax (30%) 480,000
Net income P1,120,000
*Primarily depreciation on storage facilities
As Maui handed the statement to Kim Viceroy, Pullman’s president, she commented,
“I went ahead and used the agents’ 15% commission rate in completing these
statements, but we’ve just learned that they refuse to handle our products next year
unless we increase the commission rate to 20%.”
“That’s the last straw,” Kim replied angrily. “Those agents have been demanding
more and more, and this time they’ve gone too far. How can they possibly defend a
20% commission rate?”
“They claim that after paying for advertising, travel, and the other costs of promotion,
there’s nothing left over for profit,” replied Maui.
“I say it’s just plain robbery,” retorted Kim. “And I also say it’s time we dumped those
guys and got our own sales force. Can you get your people to work up some cost
figures for us to look at?”
“We’ve already worked them up,” said Maui. “Several companies we know about
pay a 7.5% commission to their own salespeople, along with a small salary. Of
course, we would have to handle all promotion costs, too. We figure our fixed costs
would increase by P2,400,000 per year, but that would be more than offset by the
P3,200,000 (20% x P16,000,000) that we would avoid on agents’ commissions.”
The breakdown of the P2,400,000 cost figure follows:

Salaries:
Sales manager P 100,000
Salespersons 600,000
Travel and entertainment 400,000
Advertising 1,300,000
Total P2,400,000
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“Super,” replied Kim. “And I note that the P2,400,000 is just what we’re paying the
agents under the old 15% commission rate.”
“It’s even better than that,” explained Maui. “We can actually save P75,000 a year
because that’s what we’re having to pay the auditing firm now to check out the
agents’ reports. So our overall administrative costs would be less.”
“Pull all of these number together and we’ll show them to the executive committee
tomorrow,” said Kim. “With the approval of the committee, we can move on the
matter immediately.”
Required:
Answer the following questions:
1. What is the breakeven point in pesos for next year assuming that the agents’
commission rate remains unchanged at 15%?
2. What is the breakeven point in pesos for next year assuming that the agents’
commission rate is increased to 20%?
3. What is the breakeven point in pesos for next if the company employs its own
sales force?
4. Assume that Pullman Company decides to continue selling through agents

and pays the 20% commission rate. The volume of sales that would be
required to generate the same net income as contained in the budgeted
income statement for next year would be:
5. The volume of sales at which net income would be equal regardless of

whether Pullman Company sells through agents at a 20% commission rate or
employs its own sales force:
In a Nutshell
PROBLEM 1:
For Del-V Company which manufactures and sells a single product line, the following
data for 2019 are available:
Unit selling price P 20
Unit variable cost 10
Unit contribution margin P 10
Total fixed costs P100,000
Required:
1. Prepare a break-even chart for the operations in 2019 in intervals of 5,000
units from 5,000 units to 30,000 units.
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2. Prepare a profit-volume graph showing the profit line for 2019. Use intervals
of 5,000 units from 5,000 units to 30,000 units.
Q&A List
1.
2.
3.
4.
5.
Keywords index
Cost-volume-profit Fixed cost
Contribution margin Desired profit
Break-even point Margin of safety
Variable cost Operating leverage
Self-help
lesson:

Co., Inc.
Big Picture
Week 8 & 9: Unit Learning Outcomes (ULO): At the end of the unit, you are
expected to:
a. explain the concept and objective of responsibility accounting system.
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b. describe the concept of cost of quality.
Big Picture in Focus: ULOa.explain the concept and objective of responsibility

accounting system.
Metalanguage
1. Responsibility accounting – is a specific unit of an organization assigned to
a manager who is held accountable for its operations and resources.
Essential Knowledge
Managers are vital in the organization’s success and survival. Manages were given
certain authority to decide for the attainment of the organization’s goal. Each
manager’s performance is judged by how well he or she manages those items under
his or her control. The manager is then held responsible for the deviations between
budgeted goals and actual results.
1. Responsibility center – is a specific unit of an organization assigned to a

manager who is held accountable for its operations and resources. Each
manager’s performance is judged by how well he or she manages those items
under his or her control.
2. Responsibility accounting – is central to any effective profit planning and

control system. It is a system that recognizes various decision centers throughout
an organization and traces cost, revenues, assets and liabilities where pertinent
by areas of responsibility. It operates on the premise that managers should be
held responsible for their performance, the activities of their subordinates and all
activities within their responsibility center.
Through responsibility accounting, managers will complied to set managerial targets

and formulate strategies to attain the firm’s overall objectives. Control mechanism
will be provided which will serve as the basis in evaluating actual results or
performance.
2.1. Advantages of Responsibility Accounting

• It facilitates delegation of decision-making.
• It helps management promotes the concept of management by objective
wherein managers agree on a common set of goals and their performance
evaluated on the basis of their attainment of goals.
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• It aids in establishing standards of performance which are used in evaluating

the efficiency and effectiveness of the different units in the organization.
• It permits effective use of management by exception which provides that the
manager will maximize his efficiency by concentrating on those operational
factors which are deviations from plans.
2.2. Disadvantages of Responsibility Accounting

• The negative effect of some decision made in one subunit to the other subunit
or to the organization as a whole.
• Decentralization necessitates a more elaborate reporting system, hence the
costs of gathering and reporting data increases.
• The problems of job duplication or overlapping of functions are usually
encountered.
2.3. Prerequisites to the Initiation and Maintenance of an Effective

Responsibility Accounting System
1) A well-defined organization structure
This requires that the spheres of jurisdiction which are set forth in the
organization chart must be clearly established and that a manager’s financial
responsibility be defined in advance.
2) Well-defined and established standards of performance in revenues, costs

and investments.
This requires that an integrated plans for the control of operation, as well as
the necessary procedures to effectuate the plan should be established and
maintained.
3) A system of accounting that identifies any revenues, expenses and assets to

specific units in the organization.
4) A system that provides for the preparation of regular performance reports.

This requires that a system of preparing the regular reports showing the
planned results, actual results and the variances should be established.
2.4. Responsibility Centers and their Evaluation
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The types of responsibility centers are cost center, profit center, investment
center and revenue center.
I. Cost Center
This is a unit within the organization wherein the manager is responsible for
minimizing costs or expenses subject to some output constraints. Example
are maintenance department of a manufacturing company, library section of
a school and accounting department of a trading concern.
Performance of a cost center is evaluated through responsibility cost

report based on standard costs and flexible budgets. To have a fair
evaluation of the cost center performance, the variance analysis report
should highlight those costs that are controllable by the manager of the
department concerned.
Types of Costs in Responsibility Cost Report
1. Controllable costs – are costs which may be directly regulated at a
given level of managerial authority.
2. Noncontrollable costs – are costs that may not be directly regulated at
a given level of managerial authority.
3. Direct costs – are costs that can be specifically identified to a certain
responsibility center. Thus, all controllable costs are direct costs, but not
all direct costs are controllable costs.
4. Indirect costs – are composed mostly of costs that are merely allocated
to the responsibility center under consideration. Therefore, are
noncontrollable by the manager of the segment to which the cost is
allocated.
Sample Problem:
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Shown below is a comparison between the budgeted and actual costs data for the
mixing department headed by Mr. Roland Lopez.
Budget Actual
Salaries & Wages P20,000 P20,000
Supplies 8,000 12,000
Postage & Telephone 2,500 3,700
Repairs & Maintenance 4,000 2,500
Depreciation 3,000 2,000
Light & Water 2,000 2,800
The decrease in depreciation cost is due to the disposal of equipment during the
period. The disposal was approved by the Vice President for Production when Mixing
Department reported that the equipment was not functioning efficiently. The increase
in light and water cost is due to the adjustment in power rates imposed by the DLPC.
Required: Determine the net amount of cost variance that must be considered in
evaluating the performance of the Mixing Department.
SOLUTION:
Budget Actual Variance Remarks
Direct Costs:
Controllable Costs:
Salaries & Wages P20,000 P20,000 -
Supplies 8,000 12,000 4,000 unfavorable
Postage & Telephone 2,500 3,700 1,200 unfavorable
Repairs & Maintenance 4,000 2,500 1,500 favorable
Non-controllable Cost:
Depreciation 3,000 2,000 -
Indirect Costs:
Light & Water 2,000 2,800 -
TOTAL P3,700 unfavorable
II. Profit Center
This is a unit or segment within the organization wherein the manager is

responsible for the generation or revenues and control of cost incurred in the
center. Examples are loans and discounts department of a commercial
banks, ladies wear section of a department store and college department of a
university.
Performance of a profit center is measured by using the contribution

approach to cost allocation or the determination of the profit center’s
contribution to indirect costs of the company. The operating performance of
the profit center is generally considered satisfactory if it is able to generate or
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even exceed the expected contribution to indirect cost or common costs of

the company.
III. Investment Center
This is a unit or segment within the organization where the manager is

responsible for the control of revenues, costs and investment made in that
center. Examples include corporate headquarters or division of a large
decentralized organization such as:
• Branch offices of commercial banks
• Pharmaceutical division
• Subsidiary companies
In addition to performance reports, the performance of an investment center is

also measured with the determined of its return on investment, residual
income and economic value added.
The objective of an investment center or business unit are:

a) Motivate managers to exert a high level of effort to achieve the goals of
the firm.
b) Provide the right incentive for managers to make decisions that are
consistent with the goals of top management.
c) Determine fairly the rewards earned by the managers for their effort
and skill
Return on Investment (ROI)
ROI is a performance measure used to evaluate the efficiency of an

investment or compare the efficiency of a number of different investment.
Advantages of ROI:
1) It is easily understood and has gained wide usage.
2) It is comparable to interest rates of returns of alternative investments.
Limitations of ROI:
1) Although ROI is widely used in evaluating performance, this method is
subject to some criticisms.
2) It results to disincentive for high ROI units to invest in projects with ROI
greater than the minimum rate of return but less than unit’s current
ROI.
Formula of ROI:
Net Operating Income

ROI =
Average Operating Assets
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Alternative Formula for ROI:

Net Operating Income Sales
ROI = X
Sales Average Operating Assets
Operating Profit Margin X Asset Turnover (Return on

ROI =
sales)
Net operating income (sometime referred to as Earnings before interest and

taxes or EBIT) – is generally used because it is consistent with the base to
which it is applied, that is, operating assets.
Operating assets – include cash, accounts receivable, inventory, plant and

equipment (net) and all other assets held for productive use in the
organization.
Residual Income
Residual income is the net operating income that an investment center is bale
to earn above some minimum return on the operating assets. Generally,
larger the residual income figure, the better is the performance rating received
by the division’s manager.
Advantages of Residual Income:

1) A unit pursues an investment opportunity costs as long as the return
from the investment exceeds the minimum rate of return set by the
firm.
2) The firm an adjust the required rate of return for difference in risk and
types of assets.
3) It is possible to calculate a different investment charge for different
types of assets.
Limitations of Residual Income:

1) It is not as intuitive as ROI.
2) It may be difficult to obtain a minimum rate of return.
Formula of Residual Income:

Operating Income P XXX
Less: Minimum required return XXX
(Operating Assets*rate of return)
Residual Income XXX
Economic Value Added (EVA)
EVA is a business unit’s income after taxes and after deducting the cost of
capital. The cost of capital is usually obtained by calculating a weighted
average of the cost of the firm’s two sources of funds – borrowing and selling
stock.
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The main advantage of using EVA is that it focuses manager’s attention of

creating for shareholders by earning profit greater than the firm cost of capital.
Formula of EVA:
EVA = Net operating income after taxes - (Invested capital*WACC)
Alternative formula:
Operating Income after tax P XXX
Less: desired income XXX
[(Total assets – Current Liabilities)*WACC]
EVA XXX
Sample Problem:
Image Company’s Printing Division incurred the following costs and expenses in
2018:
Direct materials P 400,000
Direct labor 300,000
Factory overhead (37.5% is fixed) 224,000
Selling & administrative (60%fixed) 156,000
Total P 1,080,000
During the year, the division was able to print 400,000 copies. It charged an average
of P4.00 per copy. Digital’s investment in the division amounted to P2,000,000 on
January 1, 2018. This amount increase by P800,000 at the end of the year. Digital
normally computes interest on investments at 18% of average invested capital.
Required:
A. Rate of return on average investment for the year 2018.
B. Residual income (loss) for the year ended December 2018.
C. If the weighted average cost of capital (WACC) is 10% and a tax rate of 30%,
what is the division’s economic value added?
Solution:
A. Return on average investment (ROI)
P520,000
ROI = = 21.67%
P2,400,000
Sales (400,000 cps.*P4.00) P1,600,000

Less: Variable Costs:
Direct materials 400,000
Direct labor 300,000
Factory overhead (224,000*62.5%) 140,000
Selling & administrative (156,000*40%) 62,400
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Total variable costs 902,400

Contribution margin P 697,600
Fixed Costs:
Factory overhead 84,000
(224,000*37.5%)
Selling & administrative 93,600
(156,000*60%)
Total fixed costs 177,600
Operating Income P520,000
(P2,000,000+2,800,000)
Average Operating Assets =
2
= P 2,400,000
B. Residual Income
Operating Income P 520,000
Less: Minimum required return 432,000
(2,400,000*18%)
Residual Income 88,000
C. Economic Value Added

EVA = P364,000 - (P2,400,000*10%)
= 364,000 - 240,000
= P 124,000
*P520,000*(1-.30)
IV. Revenue Center

This us a unit or segment within organization where the manager us
responsible for selling budgeted quantities of various products or services at
budgeted price. Examples of manager of revenue center are:
• A sales representative selling bread to supermarket
• A sales manager distributing automobile to dealers in specific
geographic areas
• A manager of the toys department in a local department store.
Managers of revenue centers use variance in sales price and sales mix to
monitor or control their operations. Managers of revenue centers are
responsible for achieving budgeted levels of contribution margin by controlling
the number of unit sold, product mix and selling prices.
Three types of variance and their formulas are useful to revenue center
manager in meeting their goals:
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1) Sales Price Variance
SPV = (Actual Sales Price – Master budget Actual

X
sales price) unit sales
This variance shows how much of the difference between actual and
budgeted contribution margin is caused by the difference between
actual and budgeted sales prices.
2) Sales Volume Variance
SVV = (Actual unit sales – Master X Master budget

budget unit sales) average contribution
margin per unit*
*Master budget Master budget total contribution margin

average
=
contribution Master budget sales
margin per unit
This variance measures the difference between actual unit sales and
budgeted unit sales.
3) Sales Mix Variance
Flexible Master
budget budget
Actual
average average
SMV = - X unit
contribution contribution
sales
margin per margin per
unit ** unit
**Flexible Flexible budget total contribution

budget margin
average =
contribution Actual unit sales
margin per unit
This variance is a measure of the change in contribution margin

caused by selling products in proportions (mix) different from those that
were budgeted.
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Sample Problem:
Chips Galore sells two RISC chips to small machine tool manufacturers: R66 and
R100. Pertinent data for 2018:
BUDGETED ACTUAL
R66 R100 R66 R100
Selling price per chip P 50 P 160 P 55 P 155
Variable cost per chip 40 90 43 95
Contribution margin P 10 P 70 P 12 P 60
Fixed cost per chip 6 30 5 25
Operating income P4 P 40 P7 P 35
Sales in units 1,200 400 1,000 1,000
Required:
A. Sales price variance
B. Sales volume variance
C. Sales mix variance
Solution:
A. Sales Price Variance
SPV = (Actual Sales Price – Master budget Actual
X
sales price) unit sales
For R66:
SPV = (P55 – P50) X 1,000
= P5,000 favorable
For R100:
SPV = (P155 – P160) X 1,000
B. Sales Volume Variance

SVV = (Actual unit sales – Master X Master budget
budget unit sales) average contribution
margin per unit*
SVV = (2,000 – 1,600) X 25

= P10,000 favorable
*Master budget average (P10*1,200) + (P70*400)

=
contribution margin per unit 1,600
= P25.00
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C. Sales Mix Variance
Flexible Master
budget budget
Actual
average average
SMV = - X unit
contribution contribution
sales
margin per margin per
unit ** unit
SMV = (P40 – P25) X 2,000

= P30,000 Favorable
**Flexible budget average (P10*1,000) + (P70*1,000)

contribution margin per =
unit 2,000
= P40
3. Transfer pricing – is the value of goods or services transferred by one segment

to another segment within the company, therefore, a transfer price is an internal
price that is charged by one responsibility center to another responsibility center
for goods and services.
The transfer price of interdivisional sales will affect the selling division’s sales and
the buying division’s costs but will not have any direct effect on the company’s
profit. However, the transfer price policy of the company can have an indirect
effect on company profit by influencing decisions of the division manager.
3.1. Transfer Pricing Methods

1) Minimum transfer price – the price set by transfer pricing formula is equal to
the differential costs (generally the variable costs) of the goods being
transferred, plus the contribution margin per unit that is lost to the selling
division as a result of giving up outside sales.
Transfer price = differential costs per unit + lost contribution margin per unit
2) Market based transfer price – the price at which the goods are sold in the
outside market. This is the best transfer price in the sense that it will maximize
the profits of the company as a whole provided that a competitive market
exists, and divisions are independent of each other.
3) Cost based pricing – this is based on either the variable costs or full cost of
the product. It includes the following:
a. Variable cost transfer price– is based only on variable or differential
costs. But when fixed costs increase because of a transfer of goods
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between segments, they are differential costs and therefore should be

included in the transfer price.
b. Full cost transfer price – includes all manufacturing costs (variable and
fixed) plus portion of marketing and administrative costs.
c. Full absorption cost based transfer price –only the manufacturing costs
(variable and fixed) should be included in determining the transfer
price.
d. Cost plus transfer – these method generally apply a normal markup to
costs as a substitute for market prices when intermediate market prices
are not available.
4) Negotiated transfer price – managers are permitted to negotiate the price

for internally transferred goods and services. The negotiated price is an
attempt to stimulate an arm’s length transaction between supplying and
buying segment.
3.2. Standard costs in Transfer pricing

When a firm uses the standard cost accounting system, it is advisable to use
standard costs instead of actual costs in the determination of transfer prices. This
is to avoid passing on to another division the inefficiencies or efficiencies
(variances) in the manufacturing operations of the selling divisions.
Sample problem:
The Teens Division of Mike’s RTW produces teens’ wear which it sells to the
company’s Sales Division. Cost and production data for the past year are presented
below:
Production in units 5,000
Direct materials P100,000
Direct labor 75,000
Factory overhead (60% fixed) 125,000
Selling & administrative (10% variable) 150,000
Required:
A. Full costs
B. Full costs plus 20%
C. Full production costs plus 40%
D. Variable costs
E. Variable manufacturing costs plus 60%
Solution:
A. Full costs
Direct labor 75,000
Total costs P 450,000
Divided by: Production in units 5,000
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Transfer price P90.00
B. Full costs plus 20%

Direct labor 75,000
Cost per unit 90.00
Add: Markup (90*20%) 18
C. Full production costs plus 40%

Direct labor 75,000
Cost per unit 60.00
Add: Markup (60*40%) 24.00
D. Variable costs
Direct labor 75,000
Factory overhead (125,000*40%) 50,000
Selling & administrative (150,000*10%) 15,000
Total variable costs P 240,000
E. Variable manufacturing costs plus 60%

Direct labor 75,000
Factory overhead (125,000*40%) 50,000
Total variable manufacturing costs P 225,000
variable manufacturing costs per unit P45.00
Add: Markup (45*60%) 27.00
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Let’s Check!
I. Questions:
1. Distinguish between a cost center, a profit center, and an investment
center?
________________________________________________________
________________________________________________________
________________________________________________________
2. Define the term transfer pricing and why are transfer pricing systems
needed?
________________________________________________________
________________________________________________________
________________________________________________________
II. True or False

_____ 1. Under a responsibility accounting system, fewer expenses

are charged against managers the higher one moves
upward in an organization
_____ 2. Responsibility accounting functions most effectively in
decentralized organizations.
_____ 3. Return on investment (ROI) encourages managers to
accept all investment decisions that will benefit the
company as a whole when it is used as a measure of
performance.
_____ 4. Whenever the selling division must give up outside sales
in order to sell internally, it has an opportunity cost that
should be considered in setting the transfer price.
_____ 5. If transfer prices are to be based on cost, then the costs
should be actual costs rather than standard costs.

1) Which of the following statements is correct concerning return on investment

calculations?
a. Marginequalsstockholders'equitydividedbysales.
b. Returnoninvestmentequalsmargindividedbyturnover.
c. Turnoverequalsreturnoninvestmentdividedbymargin.
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d. Salesequalsturnoverdividedbymargin.
2) Managerial performance can be measured in many different ways including

return on investment (ROI) and residual income. A good reason for using
residual income instead of ROI is:
a. Residual income can be computed without having to measure
operating assets.
b. Managers are more likely to accept projects that are beneficial to the
company.
c. ROI does not take into account both turnover and margin.
d. A minimum rate of return does not have to be specified when the
residual income approach is used.
3) Transfer prices
a. reduce employee turnover.
b. are necessary for investment centers.
c. should encourage the kinds of behavior that upper-level management
wants.
d. are not used for departments with high amounts of fixed costs.
4) The following selected data pertain to the belt division of Allen Corp. for last
year:
Sales P500,000
Average operating assets P200,000
Net operating income P80,000
Turnover 2.5
Minimum required return 20%
How much is the return on investment?
a. 40% c. 16%
b. 20% d. 15%
5) Division A had the following information:

Asset base in Division A P800,000
Net income in Division A P100,000
Operating income margin for Division A 20%
Target ROI 15%
Weighted-average cost of capital 12%
What is EVA for Division A?
a. P120,000 c. P15,000
b. P96,000 d. P4,000
6) Company Y is highly decentralized. Division X, which is operating at capacity,

produces a component that it currently sells in a perfectly competitive market
for P13 per unit. At the current level of production, the fixed cost of producing
this component is P4 per unit and the variable cost is P7 per unit. Division Z
would like to purchase this component from Division X. What would be the
price that Division X should charge Division Z?
a. P 7 b. P 9
86
c. P 11 d. P 13
Let’s Analyze
PROBLEM 1:
The Motor Division of Super Truck Co. uses 5,000 carburetors per month in its
production of automotive engines. It presently buys all of the carburetors it needs
from two outside suppliers at an average cost of P100. The Carburetor Division of
Super Truck Co. manufactures the exact type of carburetor that the Motor Division
requires. The Carburetor Division is presently operating at its capacity of 15,000
units per month and sells all of its output to a foreign car manufacturer at P106 per
unit. Its cost structure (on 15,000 units) is:
Variable production costs P70
Variable selling costs 10
All fixed costs 10
Assume that the Carburetor Division would not incur any variable selling costs on
units that are transferred internally.
1) What is the maximum of the transfer price range for a transfer between the
two divisions?
2) What is the minimum of the transfer price range for a transfer between the two
divisions?
In a Nutshell
A multiple-division company is considering the effectiveness of its transfer pricing
policies. One of the items under consideration is whether the transfer price should be
based on variable production cost, absorption production cost, or external market
price. Describe the circum- stances in which each of these transfer prices would be
most appropriate
Q&A List
1.
2.
3.
4.
5.
87
Keywords index
Responsibility accounting Cost center
Profit center Investment center
Revenue center Transfer price
Self-help
lesson:

Co., Inc.
Big Picture in Focus: ULOb. describe the concept of cost of quality.
Metalanguage
1. Quality –isa measure of excellence or a state of being free from defects,
deficiencies and significant discrepancies. It is brought by strict and consistent
commitment to standards that achieve uniformity of a product in order to
satisfy the customers.
Essential Knowledge
88
Managing quality is vital for small businesses in order to achieve success in its
operation.Having quality products it helpsto maintain customer satisfaction and
loyalty and reduce the risk and cost of replacing faulty goods.
1. Production view of quality
Productivity is measured by the quantity of good output generated from a specific

amount of input during a time period. Any factor that either slows down a production
process or causes redundancy it hampers productivity. Activity analysis is performed
to explain the causes of these factors.
2. Consumers view of quality
The consumer’s view of quality reflects on whether the product or service delivers
as it was intended, its rate of failure, or the probability of purchasing a defective unit.
The customer perceives quality asa product’s or service’s ability to meet and satisfy
all specified needs.
Characteristics of a Product Quality Characteristics of a Service Quality

1. Performance 1. Reliability
2. Features 2. Assurance
3. Reliability 3. Tangibles
4. Conformance 4. Empathy
5. Durability 5. Responsiveness
6. Serviceability
7. Aesthetics
8. Perceived quality
3. Benchmarking – means investigating, comparing, and evaluating a company’s

products, processes, and/or services against either those of competitors or
companies believed to be the “best in class.”
3.1. Steps in Benchmarking
89
4. Total quality management (TQM)– is a “management approach of an
organization, centered on quality, based on the participation of all its members
and aiming at long-term success through customer satisfaction, and benefits to
all members of the organization and to society.”
5. Types of Quality Costs
Quality costs are the costs related with prevention, detection, and restoration of
product issues related to quality. Quality costs doesn’t mean upgrading the
perceived value of a product to a higher standard. Instead, quality involves creating
and delivering a product that meets or exceed the customer’s expectation.
Quality costs fall into four categories, which are:
Prevention costs – these are costsincurred in order to keep a quality problem

from occurring. It is the least expensive type of quality cost, and so is highly
recommended. Prevention costs can include proper employee training in
assembling products and statistical process control (for spotting processes
that are beginning to generate defective goods), as well as a robust product
design and supplier certification. A focus on prevention tends to reduce
preventable scrap costs, because the scrap never occurs.
Appraisal costs – refers to the cost needed to keep a quality problem from
occurring. This is done through a variety of inspections. The least expensive
is having production workers inspect both incoming and outgoing parts to and
from their workstations, which catches problems faster than other types of
inspection. Other appraisal costs include the destruction of goods as part of
the testing process, the depreciation of test equipment, and supervision of the
testing staff.
Internal failure costs – an internal failure cost is incurred when a defective

product is produced. This appears in the form of scrapped or reworked goods.
The cost of reworking goods is part of this cost.
External failure costs – an external failure cost when a defective product was
produced, but now the cost is much more extensive, because it includes the
cost of product recalls, warranty claims, field service, and potentially even the
legal costs associated with customer lawsuits. It also includes a relatively
unquantifiable cost, which is the cost of losing customers.
90
91
A firm spends larger amounts on prevention and appraisal costs, the number of
defects is lower and the costs of failure are smaller. If less is spent on prevention
and appraisal, the number of defects is greater and failure costs are larger. The
external failure costs curve begins moving toward vertical when customers
encounter a certain number of defects. The ultimate external failure cost is reached
when customers will no longer buy a given product or any other products made by a
specific firm because of perceived poor quality work.
An information feedback loop should be in effect to link the types and causes of
failure costs to future prevention costs. Alert managers and employees continuously
monitor failures to discover their causes and adjust prevention activities to close the
gaps that allowed the failures to occur. These continuous rounds of action, reaction,
and action are essential to continuous improvement initiatives.
High quality allows a company to improve current profits, either through lower costs
or, if the market will bear, higher prices. But management is often more interested in
business objectives other than short-run profits. An example of an alternative,
competing objective is that of increasing the company’s market share. Indeed, if
92
increasing market share were an objective, management could combine the
strategies of increasing quality while lowering prices to attract a larger market share.
Giving greater attention to prevention and appraisal activities increases quality, with
the result that overall costs decline and productivity increases. Lower costs and
greater productivity support lower prices that, in turn, often stimulate demand.
Greater market share, higher long-run profits, and, perhaps, even greater immediate
profits result.
Let’s Check!
I. Questions:
1. Why are high-quality products and services so important in today’s global

businessenvironment?
________________________________________________________
________________________________________________________
________________________________________________________
2. What is meant by the term quality?

________________________________________________________
________________________________________________________
________________________________________________________
II. Multiple Choice:

1) An all-inclusive definition of quality views it as the ability of products/services

to
a. only meet internal design specifications.
b. meet the customer's stated or implied needs.
c. be produced using all value-added production activities.
d. be produced with no rework costs.
2) Which of the following is false as it relates to quality?

a. Quality is the total of all characteristics of a product or service that impacts
on its ability to meet the needs of a specific person.
b. Quality must always be viewed from the user's perspective.
c. Quality is never concerned with what the user thinks, feels, or deems
important.
d. The definition of quality has evolved through time and is more currently
comprehensive than in the past.
3) Denison Company's cost of compliance is P58,000. Appraisal cost is P21,000

and failure cost is P32,000. The company's total quality cost is
a. P53,000.
b. P79,000.
93
c. P90,000.
d. P111,000.
For Questions 4 –
Variance Corporation is a manufacturer of a versatile statistical calculator. The

following information is a summary of defective and returned units for the previous
year.
Total defective units 1,000

Number of units reworked 750
Number of customer units returned 150
Profit for a good unit P40
Profit for a defective unit P25
Cost to rework a defective unit P10
Cost of a returned unit P15
Total prevention cost P10,000
Total appraisal cost P5,000
4) Refer to Variance Corporation. The profit lost by selling defective units not
reworked is
a. P25,000. c. P18,750.
b. P15,000. d. P3,750.
5) Refer to Variance Corporation. The total rework cost is

a. P7,500. c. P2,500.
b. P15,000. d. P3,750.
6) Refer to Variance Corporation. The cost of processing customer returns is

a. P9,000. c. P22,500.
b. P2,500. d. P2,250.
7) Refer to Variance Corporation. The total failure cost is

a. P15,000. c. P11,250.
b. P13,500. d. P8,250.
8) Refer to Variance Corporation. The total quality cost is

a. P15,000. c. P28,500.
b. P15,750. d. P11,250.
Let’s Analyze
Alpine Sunglasses Company has gathered the following information pertaining to
quality costs of production for June 2020 of heavy-duty sunglasses for skiing:
Total defective units 300
Number of units reworked 190
Number of units returned 50
94
Total prevention cost P12,000
Total appraisal cost P6,000
Per-unit profit for defective units P10
Per-unit profit for good units P28
Cost to rework defective units P8
Cost to handle returned units P5
Using these data, calculate the following:

a. Total cost to rework
b. Profit lost from not reworking all defective units
c. Cost of processing customer returns
d. Total failure costs
e. Total quality cost
In a Nutshell
By building quality into the process, rather than making quality inspections at the end
of the process, certain job functions (such as that of quality control inspector) can be
eliminated. Additionally, the installation of automated equipment to monitor product
processing could eliminate some line worker jobs.
In a nation with fairly high unemployment, would employers attempting to implement

valid quality improvements that resulted in employee terminations be appreciated or
condemned? Discuss your answer from the standpoint of a variety of concerned
constituencies, including the consumers who purchase the company’s products.
Q&A List
1.
2.
3.
4.
5.
Keywords index
Quality Benchmarking
Compliance cost Failure cost
95
Self-help
lesson:

Co., Inc.
Course Schedules
Activities Date Where to Submit

Big Picture (Week 1-3) ULOa: Let’s Check August 21, CF email/Quipper
and Lets Analyze Activities 2020
Big Picture (Week 1-3) ULOa: In a Nutshell August 22, CF email/Quipper
Activity 2020
Big Picture (Week 1-3) ULOb: Let’s Check August 26, CF email/Quipper
Big Picture (Week 1-3) ULOb: In a Nutshell August 27, CF email/Quipper
Activity 2020
Big Picture (Week 1-3) ULOc: Let’s Check September 1, CF email/Quipper
Big Picture (Week 1-3) ULOc: In a Nutshell September 2, CF email/Quipper
Activity 2020
FIRST EXAM September 4, Quipper
2020
Big Picture (Week 4-5) ULOa: Let’s Check September 9, CF email/Quipper
Big Picture (Week 4-5) ULOa: In a Nutshell September 10, CF email/Quipper
Activity 2020
Big Picture (Week 4-5) ULOb: Let’s Check September 15, CF email/Quipper
96
Big Picture (Week 4-5) ULOb: In a Nutshell September 16, CF email/Quipper
Activity 2020
SECOND EXAM September 18, Quipper
2020
Big Picture (Week 6-7) ULOa: Let’s Check September 23, CF email/Quipper
Big Picture (Week 6-7) ULOa: In a Nutshell September 24, CF email/Quipper
Activities 2020
Big Picture (Week 6-7) ULOb: Let’s Check September 29, CF email/Quipper
Big Picture (Week 6-7) ULOb: In a Nutshell September 30, CF email/Quipper
Activities 2020
THIRD EXAM October 2, Quipper
2020
Big Picture (Week 8-9) ULOa: Let’s Check October 7, CF email/Quipper
Big Picture (Week 8-9) ULOa: In a Nutshell October 8, CF email/Quipper
Activities 2020
Big Picture (Week 8-9) ULOb: Let’s Check October 12, CF email/Quipper
Big Picture (Week 8-9) ULOb: In a Nutshell October 13, CF email/Quipper
Activities 2020
FINALS October 15-16, Quipper
2020
Online Code of Conduct

1) All teachers/Course Facilitators and students are expected to abide by an
honor code of conduct, and thus everyone and all are exhorted to exercise
self-management and self-regulation.
2) Faculty members are guided by utmost professional conduct as learning

facilitators in holding OBD and DED conduct. Any breach and violation shall
be dealt with properly under existing guidelines, specifically on social media
conduct (OPM 21.15) and personnel discipline (OPM 21.11).
3) All students are likewise guided by professional conduct as learners in

attending OBD or DED courses. Any breach and violation shall be dealt with
properly under existing guidelines, specifically in Section 7 (Student
Discipline) in the Student Handbook.
4) Professional conduct refers to the embodiment and exercise of the

University’s Core Values, specifically in the adherence to intellectual
honesty and integrity; academic excellence by giving due diligence in virtual
class participation in all lectures and activities, as well as fidelity in doing
97
and submitting performance tasks and assignments; personal discipline in
complying with all deadlines; and observance of data privacy.
5) Plagiarism is a serious intellectual crime and shall be dealt with accordingly.

The University shall institute monitoring mechanisms online to detect and
penalize plagiarism.
6) All borrowed materials uploaded by the teachers/Course Facilitators shall be

properly acknowledged and cited; the teachers/Course Facilitators shall be
professionally and personally responsible for all the materials uploaded in
the online classes or published in SIM/SDL manuals.
7) Teachers/Course Facilitators shall devote time to handle OBD or DED

courses and shall honestly exercise due assessment of student
performance.
8) Teachers/Course Facilitators shall never engage in quarrels with students

online. While contentions intellectual discussions are allowed, the
teachers/Course Facilitators shall take the higher ground in facilitating and
moderating these discussions. Foul, lewd, vulgar and discriminatory
languages are absolutely prohibited.
9) Students shall independently and honestly take examinations and do

assignments, unless collaboration is clearly required or permitted. Students
shall not resort to dishonesty to improve the result of their assessments (e.g.
examinations, assignments).
10) Students shall not allow anyone else to access their personal LMS account.
Students shall not post or share their answers, assignment or examinations
to others to further academic fraudulence online.
11) By handling OBD or DED courses, teachers/Course Facilitators agree and

abide by all the provisions of the Online Code of Conduct, as well as all the
requirements and protocols in handling online courses.
12) By enrolling in OBD or DED courses, students agree and abide by all the
provisions of the Online Code of Conduct, as well as all the requirements
and protocols in handling online courses.
Monitoring of OBD and DED

(1) The Deans, Asst. Deans, Discipline Chairs and Program Heads shall be
responsible in monitoring the conduct of their respective OBD classes through
the Blackboard LMS. The LMS monitoring protocols shall be followed, i.e.
monitoring of the conduct of Teacher Activities (Views and Posts) with
98
generated utilization graphs and data. Individual faculty PDF utilization reports
shall be generated and consolidated by program and by college.
(2) The Academic Affairs and Academic Planning & Services shall monitor the
conduct of LMS sessions. The Academic Vice Presidents and the Deans shall
collaborate to conduct virtual CETA by randomly joining LMS classes to check
and review online the status and interaction of the faculty and the students.
(3) For DED, the Deans and Program Heads shall come up with monitoring
instruments, taking into consideration how the programs go about the conduct
of DED classes. Consolidated reports shall be submitted to Academic Affairs
for endorsement to the Chief Operating Officer.
Course prepared by:
MARIA TERESA A. OZOA, CPA, MBA

Name of Course Facilitator/Faculty
Course reviewed by:
MARY CRIS L. LUZADA, CPA, MSA

Name of Program Head
Approved by:
GINA FE G. ISRAEL, ED D
Name of Dean
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Big Picture in Focus: ULOb.

apply the concept and objective of activity based

2. Activity based management (ABM) – is a discipline that focuses on the

Please proceed immediately to the “Essential Knowledge”.

1. Activity– is a repetitive action performed in fulfillment of business function.

2. Activity based Costing

2.1. Benefits from ABC

2.2. Criticism of ABC

2.3. Advantages and Limitations of ABC

Activity based costing provides several benefits to the manager, namely

3. Design of an ABC System

The step or activities required in designing an ABC are:

Process Value Analysis (PVA)

Identifying Activty Centers

Assigning Costs to Activity Centers

Selecting Cost Drivers

3.1. Step 1: Process Value Analysis involves the following steps:

3.1.1. Activity analysis – the process of detailing the various repetitive

3.1.2. Classification of activities:

3.1.3. Value chain – is the sequence of business functions in which value is

3.1.4. Process map – is a flowchart or diagram indicating every step that

1. Unit – level activities – which are performed each time a unit is

Unit – Level Activities

Batch – Level Activities

Product – Level Activities

Facility – Level Activities

3.3. Step 3: Assign Cost to Activity Centers

3.4. Step 4: Select Cost Drivers

Sample Problem I: Application of Activity based costing

Barmaid Company provides the following ABC costing information:

The above activities are used by department A and Department B as follows:

I. Compute for the ABC rate.

Activities Total Cost Rate

II. Allocate factory overhead.

Sample Problem II: Application of Activity based costing

Breads Soft drinks Ice cream

Activity area usage (cost driver)

Solution: Food Corner Supermarket

Breads Soft drinks Ice cream Total

Net profit margin 2.46% 5.08% 21.92% 9.30%

The ranking of products in terms of relative profitability are:

4.1. Activity based management (ABM) – is a management tool that involves

There are two categories of ABM application, namely:

4.2. Cost driver analysis

4.3. Activity analysis

Activity analysis identifies and describes the activities in an organization.

4.4. Performance measurement

2. What are the major advantages of activity based management (ABM)?

3. What four general levels of activity can be identified in a company?

II. True or False

2. A company using activity-based costing

3. A tool that focuses on manufacturing processes and seeks to reduce or optimize

4. Kimball Company produces two products in a single factory. The following

The controller has determined total overhead to be P480,000. P120,000 relatesto

5. Kimball Company produces two products in a single factory. The following

6. Kimball Company produces two products in a single factory. The following

The controller has determined total overhead to be P480,000. P120,000

7. Kimball Company produces two products in a single factory. The following

The controller has determined total overhead to be P480,000. P120,000