Performance Assessment

1. 12 C hapter Performance Assessment Prepared by Douglas Cloud Pepperdine University

2. Objectives 1. Explain responsibility accounting and differentiate between financial and nonfinancial performance measures. 2. Differentiate between static and flexible budgets used in performance reporting. 3. Determine and interpret direct materials and direct labor cost variances. 4. Prepare a performance report for a revenue center. After studying this chapter, you should be able to:

3. …or on various aspects of the value chain that are accountable for the accomplishment of specific activities or objectives. Responsibility accounting may focus on specific units within the organization... Responsibility Accounting

4. Performance Responsibility Accounting Responsibility accounting on a poorly designed system can lead to unethical practices by managers in key positions if too much pressure is placed on meeting performance targets.

5. Organizational Structure Organizational structure is the arrangement of lines of responsibility within the organization.

6. GE’s Six Sigma Program The program has five basic steps: 1.Define problem—Generally teams work to define problems related to some process or customer satisfaction. 2. Measure—Determine what is wrong with the existing process or service. 3. Analyze—Determine reasons for what is wrong. 4. Improve—Define and develop a plan of action. 5. Control—To ensure that changes are installed and used effectively, measures are implemented to keep problem from recurring.

7. From Manager: Mall 2 Financial Measures Actual CostAllowed CostVariance Vice President Operations Mall 1 $ 55,000 $ 54,800 $ 200 U Mall 2 69,600 68,400 1,200 U Vice president’s office 10,900 12,000 1,100 F Total $135,500 $135,200 $ 300 U

8. Actual CostAllowed CostVariance Manager: Mall 2 Maintenance Department $ 25,400 $ 24,700 $ 700 U Advertising Department 17,500 18,000 500 F Security Department 20,500 19,900 600 U Mall manager’s office 6,200 5,800 100 U Total $ 69,600 $ 68,400 $1,200 U From Head: Security Department To Vice President Operations Financial Measures

9. Actual CostAllowed CostVariance Head: Security Department Supplies $ 3,000 $ 2,000 $ 1,000U Staff wages 9,500 10,000 500 F General overhead 8,000 7,900 100 F Total $135,500 $135,200 $ 600 U To Manager: Mall 2 Financial Measures

10. Nonfinancial Measures as Percentages

11. Nonfinancial Measures Other measures include assessments of: productivity quality innovation • Common measures are: • unit sales volume • unit production output • quantity of material used • labor and/or machine hours

12. To Manager: Mall 2 Nonfinancial Measures Actual Expected ActivityActivityVariance Head: Security Department Absenteeism rate 12 % 6 % 6% U Security complaints per store per week 4 6 2 F

13. To Vice PresidentOperations From Head: Security Department Nonfinancial Measures Actual Expected ActivityActivityVariance Manager: Mall 2 Percentage occupancy 87 % 94 % 7 % U Absenteeism rate 10 % 5 % 5 % U Complaints per week: General 4 4 0 F Maintenance 7 6 1 U Security 4162 F Total complaints 15 16 1 F

14. From Manager: Mall 2 Nonfinancial Measures Actual Expected ActivityActivityVariance Vice President Operations Percent occupancy 92 % 98 % 6 % U Absenteeism rate 8 % 4 % 4 % U Complaints per week 45 50 5 F

15. Performance Reports Performance reports show expanded authority and responsibility for operating costs

16. Types of Responsibility Centers • Cost Center • Revenue Center • Profit Center • Investment Center

17. Types of Responsibility Centers A cost center is a responsibility center whose manager is responsible only for managing costs; there is no revenue responsibility.

18. Types of Responsibility Centers Cost Center Manufacturing Plant Tooling department Assembly activities

19. Types of Responsibility Centers Cost Center Retail store Inventory control function Maintenance department

20. Types of Responsibility Centers Cost Center TV station Audio/video engineering Building and grounds

21. Types of Responsibility Centers Cost Center College History department Student registering activities

22. Types of Responsibility Centers Cost Center City government Public safety (police and fire) Road maintenance

23. Types of Responsibility Centers A revenue center is a responsibility center whose manager is responsible for the generation of sales revenues. A profit center is a responsibility center whose manager is responsible for revenues, costs, and resulting profits. An investment center is a responsibility center whose manager is responsible for the relationship between its profits and the total assets invested in the center.

24. Manufacturing Budget McMillan Company Manufacturing Budget For the Month of July Manufacturing costs: Unit level: Direct materials (10,000 x 2 pounds X $5) $100,000 Assembly (10,000 x 0.25 hours x $24) 60,000 Waterproofing and Inspection (10,000 x $8) 80,000 Batch level: Setup (10 batches x $400) 4,000 Test run (10 batches x $100) 1,000 Product level 20,000 Facility level 32,000 Total $297,000

25. Static Budget McMillan Company Production Department Performance Report For the Month of July Original Static Budget ActualBudgetVariance Volume 11,000 10,000 Unit level: Direct materials $108,000 $100,000 $ 8,000 U Assembly 70,000 60,000 10,000 U Waterproofing and Inspection 81,000 80,000 1,000 U Batch costs: Setup 4,000 Test runs 1,000 Continued

26. Static Budget McMillan Company Production Department Performance Report For the Month of July Original Static Budget ActualBudgetVariance Volume 11,000 10,000 Batch costs: Total 5,600 5,000 600 U Fixed overhead: Product 22,000 20,000 2,000 U Facility 31,000 32,000 1,000 F Totals $317,600 $297,000 $20,600 U

27. Flexible Budget McMillan Company Production Department Performance Report For the Month of July Original Static Budget ActualBudgetVariance Volume 11,000 10,000 Unit level: Direct materials $108,000 $110,000 $ 2,000 F Assembly 70,000 66,000 4,000 U Waterproofing and Inspection 81,000 88,000 7,000 F Batch costs: Setup 4,400 Test runs 1,100 Continued

28. Flexible Budget McMillan Company Production Department Performance Report For the Month of July Original Static Budget ActualBudgetVariance Volume 11,000 10,000 Batch costs: Total 5,600 5,500 100 U Fixed overhead: Product 22,000 20,000 2,000 U Facility 31,000 32,000 1,000 F Totals $317,600 $321,500 $3,900 F

29. Standard Costs A standard cost indicates what it should cost to provide an activity or produce one batch or unit of product under planned and efficient operating conditions. Traditionally, standard costs are developed from an engineering analysis or from an analysis of adjusted historical data. Flexible budgets are based on standard costs.

30. Relational and Discretionary Cost Centers It is a center that has clearly defined relationships between effort and accomplishment. What is a relational cost center?

31. Standard and Discretionary Cost Centers A discretionary cost center is just the opposite. It doesn’t have clearly defined relationships between effort and accomplishment.

32. Direct Material Standards and Variances • Standard price indicates how much shouldbe paid for each input unit of direct materials. • Materials price variance is the difference between actual and standard cost of materials inputs. • Standard quantity indicates the amount of direct materialsallowedto produce one unit of output. • Materials quantity variance is the difference between standard cost of actual materials inputs and flexible budget cost for materials.

33. Standard Cost of Actual Inputs Actual Cost Actual quantity (AQ) 24,000 Standard price (SP) x $5 $120,000 Actual quantity (AQ) 24,000 Actual price (AP) x $4.50 $108,000 Standard Material Variances Material price variance, $12,000 F

34. Flexible Budget Cost Standard Cost of Actual Inputs Standard quantity (AQ) 22,000 Standard price (SP) x $5 $110,000 Actual quantity (AQ) 24,000 Standard price (SP) x $5 $120,000 11,000 units x 2 pounds per unit Standard Material Variances Material quantity variance, $10,000 U

35. Total flexible budget materials variance $2,000 F Standard Material Variances Standard Cost Actual Costsof Actual InputsFlexible Budget Cost (AQ) 24,000 (AQ) 24,000 (SQ) 22,000 (AP) x $4.50(SP) x $5 (SP) x $5 $108,000 $120,000 $110,000 Materials price Materials quantity variance $12,000 F variance $10,000 U

36. Interpreting Material Variances Favorable materials price varianceindicates that management paid less per unit than the price allowed by the standard • Receiving discounts for purchasing larger than normal quantities • Effective bargaining by the employee • Purchasing substandard quality materials • Purchasing from a distress seller Possible Explanations:

37. Interpreting Material Variances Unfavorable materials price variancemeans that the purchasing employee paid more per unit for material than the price allowed by the standard. • Failure to buy in sufficient quantities to get normal discounts • Purchase of higher quality material than called for in the product specs • Failure to place material orders on a timely basis • Failure to bargain for better prices Possible Explanations:

38. Interpreting Material Variances Favorable materials quantity variancemeans that the actual quantity of raw materials used was less than the quantity allowed for the units produced. • Less materials waste than allowed by the standards • Better than expected machine efficiency • Direct materials of higher quality than required by the standards • More efficient use of direct materials Possible Explanations:

39. Interpreting Material Variances Unfavorable materials quantity varianceoccurs when the quantity of raw materials used exceeds the quantity allowed for the units produced. • Incurring more waste than provided for in the standards • Poorly maintained machinery requiring larger amounts of raw materials • Raw materials of lower quality than required by the standards • Poor trained employees Possible Explanations:

40. Standard Cost of Actual Inputs Actual Cost Actual hours (AH) 2,800 Standard rate (SR) x $24 $67,200 Actual hours (AH) 2,800 Actual rate (AR) x $25 $70,000 Standard Labor Variances Labor rate variance, $2,800 U

41. Standard Cost of Actual Inputs Flexible Budget Cost Actual hours (AH) 2,800 Standard rate (SR) x $24 $67,200 Standard hours (SH) 2,750 Standard rate (SR) x $24 $66,000 11,000 units x 1/4 hour per unit Standard Labor Variances Labor efficiency variance, $1,200 U

42. Total flexible budget labor variance, $4,000 U Standard Labor Variances Standard Cost Actual Costsof Actual InputsFlexible Budget Cost (AH) 2,8000 (AH) 2,8000 (SH) 2,750 (AR) x $25(SR) x $24 (SR) x $24 $70,000 $67,200 $66,000 Labor rate Labor efficiency variance $2,800 U variance $1,200 U

43. Interpreting Labor Variances • Unfavorable assembly rate variancemay be caused by the use of higher paid laborers than provided for by the standards. • Favorable assembly rate varianceoccurs if lower paid workers are used. • Unfavorable labor efficiency variancesoccur whenever workers require more than the number of hours allowed by the standards. • Favorable labor efficiency varianceoccurs when fewer labor hours are used than are allowed by the standards

44. Performance Reports for Revenue Centers Performance reports for revenue centers include a comparison of actualand budgeted revenues. Assume that McMillan Company’s July sales budget called for the sale of 10,000 units at $40 each. If McMillan Company actually sold 11,000 units at $39 each, what would be the total revenue variance?

45. Actual volume x Actual price Budget volume x Budgeted price Revenue Variance Actual revenues (11,000 x $39) $429,000 Budgeted revenues (10,000 x $40) - 400,000 Revenue variance $ 29,000 F

46. Sales Price Variance Sales price variance = (Actual selling price – Budgeting selling price) x Actual sales volume Sales price variance = ($39 – $40) x 11,000 units Sales price variance =$11,000 U

47. Sales Volume Variance Sales volume variance = (Actual sales volume – Budgeting sales volume) x Budgeted selling price Sales volume variance = (11,000 units –10,000 units) x $40 Sales volume variance =$40,000 F

48. The net of the sales price and sales volume variances is equal to the revenue variance. Sales price variance $11,000 U Sales volume variance 40,000 F Revenue variance $29,000 F Actual revenue $429,000 Budgeted revenues 400,000 Revenue variance $ 29,000 F

49. Inclusion of Controllable Costs • Controllable costsshould also be considered when evaluating the overall performance of revenue centers. • Order getting costsare costs incurred to obtain customers’ orders. • Order filling costsare costs incurred to place finished goods in the hands of purchasers.

50. Net Sales Volume Variance Sales $40.00 Direct materials $10.00 Assembly 6.00 Variable manufacturing overhead: Unit level $8.00 Batch level 0.50 8.50 Selling 5.00 29.50 Contribution margin $10.50