Solutions to Homework Assignment - Chapter 11

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Chapter 11 Flexible Budgets, Segment Reporting, and Performance Analysis QUESTIONS 1. A static budget is one based on the level of output planned at the start of the budget period. A flexible budget calculates budgeted revenue and budgeted costs based on the actual output in the budget period. The only difference between the static budget and the flexible budget is that the static budget is prepared for the planned output, whereas the flexible budget is prepared based on the actual output. 2. A static budget variance is the difference between the actual results and the corresponding budgeted amounts in the static budget. A flexible-budget variance is the difference between an actual result and the corresponding flexible-budget amount, based on the actual output in the budget period. 3. The statement is incorrect. Top-level management usually deals with issues concerning the overall operation of the business and therefore should receive highly summarized reports. Detailed reports should be directed to the lower levels of management, where the specific, day-to-day operating decisions must be made. 4. Examples of segmentation by organizational units include departments, divisions, branches, and subsidiaries. Examples of segmentation by areas of economic activity include industries, product lines, markets, and geographic areas. 5. A profit center is a business segment for which management has assigned profit responsibility to the manager; such segments generate revenue, and some income or contribution measure is used to appraise its success. A segment that incurs costs (expenses) but does not produce revenue is often designated a cost center. Costs and expenses are measured with respect to the segment, and its manager is usually held responsible for meeting budgeted amounts. 6. Traceable expenses are those incurred specifically by a particular business segment or that can be traced directly to its operation. Common expenses are usually general expenses of the firm; they are usually not assigned or allocated to business segments. Traceable expenses are most likely to be controllable at the department level, but common expenses are not. ©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 11 11-1

7. a. Janitorial expense: square feet of floor space. b. Plant manager’s salary: relative time spent on each department. c. Utilities: square feet of floor space. d. Property taxes: square feet of floor space for real estate tax allocations; value of personal property for personal property tax allocations. 8. Departmental contribution to common expenses is the amount obtained by subtracting traceable departmental expense from departmental gross profit; this amount represents a department's contribution to common or indirect expenses and to the net income of the firm. Its main advantage is that it avoids the problems of allocating common expenses of the firm. It also emphasizes that the expenses are less likely to be controllable at the departmental level. 9. Discontinuation of Department B will result in a reduction of $22,000 in firm income before taxes, because the $22,000 contribution of Department B will be given up. 10. Contribution to common expenses will increase by $6,000 as shown below: Present Proposed Sales $250,000* $262,500 (5% increase) Cost of goods sold 150,000 150,000 Gross profit on sales $100,000 $112,500 Traceable expenses 75,000 81,500 ($6,500 increase) Contribution $25 ,000 $31 ,000 *($100,000 / 40%) 11. Contribution to common expenses will decrease by $8,000 as shown below: Increase in gross profit (20% of $140,000) $28,000 Increase in advertising expense 36 ,000 Decrease in contribution ($8 ,000) 12. If the divisions were of significantly different size, comparing operating incomes could be misleading. A better measure for comparison would be each division’s return on investment (ROI). 13. The primary purpose of the balanced scorecard is to provide a “balanced view” of company performance by evaluating a company’s subunits based on both financial and nonfinancial measures. ©Cambridge Business Publishers, 2020 11-2 Managerial Accounting for Undergraduates, 2 nd Edition

14. The four key performance measures in the balanced scorecard are: a. Financial performance, b. Customer satisfaction, c. Internal business processes, and d. Learning and growth. 15. The maximum amount would be the price paid to an outside supplier of the component. If the supplying division’s price exceeds that of an outside supplier, the company would be better off overall buying the component from the outside supplier. ©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 11 11-3

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SHORT EXERCISES SE 11-1. (LO1) a. Flexible budgets are based on actual output rather than comparing output to a static budget. Flexible budgets make it easier to identify realistic positive and negative variances. SE 11-2. (LO2) d. Flexible budgets are based on the output actually achieved and therefore provide a realistic comparison of budgeted and actual revenue and costs. SE 11-3. (LO2) b. If a company experiences an increase in sales volume, the actual revenue will be greater than the master budget revenue (favorable variance) and the actual costs will be greater than the master budget costs (unfavorable variances). SE 11-4. (LO2) c. Efficiency variances are sometimes referred to as usage variances and measure quantity used. Material usage and labor efficiency (usage) are likely to be related, e.g., poor quality material will likely cause excess usage and require additional labor. SE 11-5. (LO3) b. A sales team is generally only accountable for sales dollars; this type of responsibility center is, therefore, a revenue center. SE 11-6. (LO5) Appendix 11A c. Return on assets: Net income/average total assets = [$75,000/(($500,000 + $600,000)/2)] = 0.136 or 14% Return on equity: Net income/average equity = [$75,000/(($500,000 - $225,000) + ($600,000 - $300,000))/2] = 0.261 or 26% ©Cambridge Business Publishers, 2020 11-4 Managerial Accounting for Undergraduates, 2 nd Edition

SE 11-7. (LO5) a. Snug-fit’s return on the incremental sales would be 34.0% as shown below. Estimated bad debt loss = $80,000 x .06 = $ 4,800 Gross profit = $80,000 x .4 = $32,000 Return on sales = ($32,000 - $4,800) / $80,000 = 34.0% SE 11-8. (LO5) c. Gross profit margin percentage: Gross profit/sales = ($5,000,000 – $3,000,000)/$5,000,000 = 0.40 or 40% SE 11-9. (LO5) b. Moreland’s total asset turnover is 1.37 as calculated below. Total asset turnover = Sales / Average total assets = $900,000 / $657,000* = 1.37 *Average total assets = [($48,000 + $42,000 + $68,000 + $125,000 + $325,000 + $62,000 + $35,000 + $47,000 + $138,000 + $424,000) ÷ 2] = $657,000 SE 11-10. (LO6) Appendix 11A c. If the Robo Division submits a bid for $8,000,000, the division will lose $500,000 but GMT will gain $1,700,000 as the transfer price is not relevant to GMT. Robo Division: $8,000,000 - $3,700,000 - $4,800,000 = ($500,000) GMT Industries: $8,000,000 - $1,500,000 - $4,800,000 = $1,700,000 ©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 11 11-5

EXERCISES—SET A E11-1A. Static and Flexible Budgets (LO1, 2) a. Actual Results Flexible Budget Static Budget Units sold 400,000 400,000 430,000 Revenues $4,000,000 $4,000,000 $4,300,000 Variable costs 1,250,000 1,396,000* 1,500,000 Contribution margin $2,750,000 $2,604,000 $2,800,000 Fixed costs 1,500,000 1,290,000 1,290,000 Operating income $1,250,000 $1,314,000 $1,510,000 *$1,500,000 / 430,000 units = $3.49 / unit x 400.000 units = $1,396,000 b. Actual revenues – Static budget revenues = $4,000,000 - $4,300,000 = $300,000 unfavorable. c. Actual variable costs –Flexible budget variable costs = $1,250,000 - $1,396,000 = $146,000 favorable. d. Actual fixed costs – Flexible budget fixed costs = $1,500,000 – 1,290,000 = $210,000 unfavorable. E11-2A. Using Flexible Budgets (LO2) a. The favorable variances imply operating efficiencies relative to the standards set in the budget. However, the variances are not valid, because they result from comparing the planned costs for 10,000 units with the actual costs of 9,600 units. b. Flexible Budget (9,600 units) Actual Costs (9,600 units) Variances Direct material $134,400 (1) $136,800 $2,400 U Direct labor 268,800 (2) 277,200 8,400 U Variable overhead 92,160 (3) 98,400 6,240 U Fixed overhead 72,000 72,400 400 U Total $567,360 $584,800 $17,440 U The general tone of the revised report is the reverse of the original report; it recognizes an inefficient performance level compared with that of the budget. 1. $140,000 x (9,600/10,000) = $134,400 2. $280,000 x (9,600/10,000) = $268,800 3. $96,000 x (9,600/10,000) = $92,160 ©Cambridge Business Publishers, 2020 11-6 Managerial Accounting for Undergraduates, 2 nd Edition

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©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 11 11-7

E11-3A. Assigning Traceable Fixed Expenses (LO4) Allocation Basis: Allocation Assignment: Departmen t Equipment (Avg. Cost) Fraction Depreciation A $720,000 720/1,440 $70,000 B 432,000 432/1,440 42,000 C 288,000 288/1,440 28,000 $1,440,000 $140,000 Square Feet Real Estate Taxes A 18,000 18/30 $28,800 B 9,000 9/30 14,400 C 3,000 3/30 4,800 30,000 $48,000 Inventory + Equipment Personal Property Taxes A $80,000 + $720,000 = $ 800,000 800/1,920 $12,000 B $288,000 + $432,000 = $720,000 720/1,920 10,800 C $112,000 + $288,000 = $ 400,000 400/1,920 6,000 $1,920,000 $28,800 Note that the personnel department expenses would be considered a common cost not traceable to the departments. E11-4A. Return on Investment and Residual Income (LO4) a. ROI ROI Rank Las Vegas $960,000/$4,000,000 = 24% 1 Dallas $1,200,000/$9,600,000 = 12.5% 3 Tampa $2,280,000/$12,000,000 = 19% 2 b. Residual Income Residual Income Rank Las Vegas $960,000 NI - ($4,000,000 assets x 12%) = $480,000 2 Dallas $1,200,000 NI - ($9,600,000 assets x 12%) = $48,000 3 Tampa $2,280,000 NI - ($12,000,000 assets x 12%) = $840,000 1 ©Cambridge Business Publishers, 2020 11-8 Managerial Accounting for Undergraduates, 2 nd Edition

EXERCISES—SET B E11-1B. Using Flexible Budgets (LO20 a. The favorable variances imply operating efficiencies relative to the standards set in the budget. However, the variances are not valid, because they result from comparing the planned costs for 10,000 units with the actual costs of 9,600 units. b. Flexible Actual Budget Costs (9,600 units) (9,600 units) Variances Direct material $100,800 (1) $102,600 $1,800 U Direct labor 201,600 (2) 207,900 6,300 U Variable overhead 69,120 (3) 73,800 4,680 U Fixed overhead 54,000 54,300 300 U Total $425,520 $438,600 $13,080 U The general tone of the revised report is the reverse of the original report; it recognizes an inefficient performance level compared with that of the budget. 1. $105,000 x (9,600/10,000) = $100,800 2. $210,000 x (9,600/10,000) = $201,600 3. $72,000 x (9,600/10,000) = $69,120 ©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 11 11-9

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E11-2B. Assigning Traceable Fixed Expenses (LO4) Allocation Basis Allocation Assignment: Department Equipment (Avg. Cost) Fraction Depreciation A $360,000 360/720 $45,000 B 216,000 216/720 27,000 C 144,000 144/720 18,000 $720,000 $90,000 Square Feet Real Estate Taxes A 27,000 27/45 $67,500 B 13,500 13.5/45 33,750 C 4,500 4.5/45 11,250 45,000 $112,500 Inventory + Equipment Personal Property Taxes A $40,000 + $360,000 = $400,000 400/960 $6,000 B $144,000 + $216,000 = $360,000 360/960 5,400 C $56,000 + $144,000 = $200,000 200/960 3,000 $960,000 $14,400 Note that the personnel department expenses would be considered a common cost not traceable to the departments. E11-3B. Return on Investment and Residual Income (LO5) a. North = $750,000 Operating Income /$5,000,000 Investment = .15 South = $550,000 Operating Income /$4,400,000 Investment = .125 b. North = $750,000 Operating Income - ($5,000,000 Investment x 15% rate of return) = $0 South = $550,000 Operating Income - ($4,400,000 Investment x 15% rate of return) = ($110,000) c. North, North ©Cambridge Business Publishers, 2020 11-10 Managerial Accounting for Undergraduates, 2 nd Edition

E11-4B. Evaluating Investment Centers (LO5) ROI = Income/Investment = Income/Revenues x Revenues/Investment Foods ROI = $200,000/$2,000,000 x $2,000,000/$1,000,000 = 0.10 x 2 = 0.20 Clothes ROI = $750,000/$8,000,000 x $8,000,000/$5,000,000 = 0.09375 x 1.6 = 0.15 Terry Enterprises ROI = ($200,000 + $750,000) x ($2,000,000 + $8,000,000) ($2,000,000 + $8,000,000) ($1,000,000 + $5,000,000) = 0.095 x 1.667 = 0.1584 EXTENDING YOUR KNOWLEDGE EYK11-1. Business Decision Case Flexible budgets are preferable for both planning purposes and performance reporting as the flexible budget can be based on the actual amount of output and then compared to the actual revenue and costs. One response to give the CEO is that a static budget is based on projected output while a flexible budget is based on actual output. As a result, the actual cost of the actual output can be compared to the budgeted cost for the actual output. EYK11-2. Ethics Case a. The sales and production managers hope to increase their year-end bonus amounts. They are likely hoping this practice will not be discovered by upper management or anyone in a position to fire them or reprimand them. b. This might backfire if the corporation has effective internal controls, such as having a second review of the budgeting process. If a second review were conducted, the sales and production managers’ plots may be discovered. c. It is not unethical to work at reducing a variance by increasing sales or lowering production costs. However, behavior is more suspect when it is carried out for personal gain rather than for the good of the corporation. In this case, the managers are adjusting the budgeting process based on what benefits them personally, rather than acting in the best interests of CJ Corporation. ©Cambridge Business Publishers, 2020 Solutions Manual, Chapter 11 11-11