P1SC Performance Management

Question 1

The best basis upon which cost standards should be set to measure controllable production inefficiencies is

A. Ideal standards
B. Normal capacity
C. Attainable standards
D. Average historical peformance

Answer 1

C. Attainable Standards

Reasonably attainable standards are based on what the average trained employee should be expected to produce. Standards based on attainable performance should be used as it takes into consideration a normal amount of time lost, normal amounts of waste, and a normal learning curve. Comparison of Actual results to Attainable Standards will result in variances or production inefficiencies which are controllable. Once these controllable production inefficiencies are identified they can be rectified.

Ideal Standards assume that everything in the production cycle happens exactly as planned and are extremely difficult to achieve. It assumes no breakdowns, no waste, and every process at maximum efficiency. If standards are sest using ideal standards it would be very difficult to attain and hence ideal standards are not the best basis to measure controllable production inefficiencies as variances between ideal standards and actual performances might not all be controllable.

Normal Capacity is average level of production and Historical Performance is based on past actual results, both of these would not help us understand production inefficiencies.

Question 2

Economic Value Added (EVA)

Answer 2

EVA is operating profit after taxes, less the sum of the average invested capital times the costs of that capital for each type of capital. In other words, EVA is the net operating profit after tax, less the opportunity cost of capital.

Economic Value Added (EVA) = Net Operating Profit after Taxes - (Invested Capital x WACC)

Question 3

Weighted Average Cost of Capital

Answer 3

Wd x kd + we x ke

Where
Wd: the portion of debt in the capital structure
Kd: the pretax cost of debt
We: the proportion of equity in the capital structure
Ke: the cost of equity

Question 4

Net Operating Profit after Taxes

Answer 4

Pretax Operating Profit x (1 - Tax Rate)

Question 5

Controllable revenues would be included in the performance reports of which of the following types of responsibility centers?

Yes/no

Cost centers:
Investment Centers:

Answer 5

Cost centers: no
Investment centers: yes

The manager of a cost center is only responsible for controllable costs. Thus, controllable revenues would not be included in the performance report of a cost center.

The manager of an investment center is responsible for controllable revenues, controllable costs, and investment funds. Thus, controllable revenues would be included in the performance report of an investment center.

Question 6

Decentralized firms can delegate authority and yet retain control and monitor managers’ performance by structuring the organization into responsibility centers. Which one of the following organizational segments is most likely to an independent business?

A. Investment center
B. Profit center
C. Cost center
D. Revenue center

Answer 6

A. Investment center

Investment center manager is a manager who can influence revenues, costs, and the level of investment. Investment centers are responsible for investments, revenues, and costs. Performance of investment centers is evaluated not only by its profit but also by relating the profit to its invested capital. Investment Centers are segments that are evaluated as an independent business.

Question 7

For a given time period, a company had a favorable material quantity variance, a favorable direct labor efficiency variance, and a favorable fixed overhead volume variance. Of the following, the one factor that could not have caused any of the three variances is

A. The purchase of higher quality materials
B. The use of lower-skilled workers
C. The purchase of more efficient machinery
D. An increase in production supervision

Answer 7

B. The use of lower-skilled workers

The use of lower-skilled labor is not likely to lead to a favorable direct labor efficiency variance but more likely to cause this variance to be unfavorable. Lower-skilled labor could also affect the material quantity variance negatively.

The purchase of higher quality materials would lead to a favorable material quantity variance as better quality material would lead to less spoilage/wastage.

The purchase of more efficient machinery would lead to a greater amount of production at the given capacity and hence would lead to a favorable fixed overhead volume variance.

An increase in production supervision would make workers more efficient and hence would contribute to a favorable direct labor efficiency variance.

Question 8

Predetermined variable overhead rate

Answer 8

Estimated manufacturing overhead cost for the period
———————————————————————————
Estimated number of units within the allocation base

Question 9

Strategic planning, as practiced by most modern organizations, includes all of the following except

A. Identification of long-term key variables including external influences
B. Strategies that will help in achieving long-range goals
C. A long-term focus
D. Analysis of the current month’s actual variances from budget

Answer 9

D. Analysis of the current month’s actual variances from budget

Strategic planning also referred to as long-range planning involves a comprehensive look at an organization in relation to its industry, competitors, and environment and includes external analysis such as identification of long-term key variables including external influences, evaluating strategies that will help in achieving long-range goals and always has a long-term focus.

The analysis of the current month’s actual variances from the budget is considered a part of management control or operational control rather than a part of strategic planning.

Question 10

For April, Stock Co.’s records disclosed the following data relating to direct labor
* actual cost: $10,000
* Rate variance: 1,000 favorable
* Efficiency variance: 1,500 unfavorable
* Standard Cost: $9,500

For April, actual direct labor hours totaled 1,000. In April, Stork’s standard direct labor rate per hour was..

Answer 10

$11.00

Actual cost: $10,000
Rate variance: 1,000 F
Actual input x Std. price: 1,000 x SP
Efficiency variance: 1,500 U
Std Qty x Std Price = $9,500

1,000 hr x SP = 9500 + 1500
SP = 11,000 / 1,000hr = $11/hr

Question 11

A company’s standard cost for direct labor are as follows:

Standard quantity: 1 hour per unit
Standard price: $15 per hour

Last month, the company produced and sold 100 units of its product, using 110 direct labor hours at a rate of $16 per hour. What amount is the company’s direct labor efficiency variance for last month?

Answer 11

$150

The direct labor efficiency variance is the difference in actual quantity from the standard quantity of direct labor multiplied by the standard rate (price) per hour.

(Actual quantity - standard quantity) x standard rate per hour

(110 hours - 100 hours) x $15/hour

As the actual hours are greater than the standard hours, the variance is unfavorable.

Question 12

Jones, a department manager, exercises control over the department’s costs. Following is selected information relating to the department for July:

• Variable factory overhead
• Budgeted based on standard hours allowed: $80,000
• Actual: 85,000

*Fixed factory overhead
- Budgeted: 25,000
- Actual: 27,000

The department’s unfavorable spending variance for July was

Answer 12

$7,000

To compute the spending variance under the three-way analysis of factory overhead, budgeted variable factory overhead based on actual hours (not standard hours allowed) is needed.

Therefore, perhaps the question really intended for the budget (or controllable) variance under the two-way analysis of factory overhead to be computed. The budget (controllable) variance is the difference between actual factory overhead incurred and budgeted factory overhead based on standard hours allowed.

The actual factory overhead incurred is $112,000 (85,000+27,000). The budgeted factory overhead based on standard hours allowed is $105,000 ($80,000+$25,000)

Therefore, the budget (controllable) variance is $7,000 unfavorable (112,000 - 105,000)

Question 13

Which of the following methods is best suited for evaluating the performance of a firm’s capital in any given year?

A. Internal rate of return
B. Net present value
C. Economic value added
D. Payback

Answer 13

C. Economic Value Added

Economic Value-added (EVA) is best suited for evaluating the performance of firm’s capital in a given year. Economic value added: operating profit - cost of capital = residual wealth i.e. the extra value added after all costs including cost of capital

Internal Rate of Return (IRR), Net Present Value (NPV), and payback are capital budgeting techniques that evaluate the performance of a project or investment over a period of time.

Question 14

Most firms use return on investment (ROI) to evaluate the performance of investment center managers. If top management wishes division mangers to utilize all assets without regard to financing, the denominator in the ROI calculation will be

A. Total assets employed
B. Total assets available
C. Working capital
D. Working capital plus other assets

Answer 14

B. Total assets available

Total assets available is more inclusive than total assets employed. The difference between the two might be land that is being held for future expansion of the factory. The total assets available is the better choice because the question says all assets. As the division manager has the authority to utilize all assets without regard to financing all the assets available to him would be a better base (denominator) for ROI calculation.

Question 15

A company’s standard cost for direct labor are as follows:

Standard quantity: 1 hour per unit
Standard price: $15 per hour

Last month, the company produced and sold 100 units of its product, using 110 direct labor hours at a rate of $16 per hour. What amount is the company’s direct labor efficiency variance for last month?

Answer 15

$150

Direct labor efficiency variance is the difference between actual hours and the standard hours allowed for actual production.

(Standard hours for actual production x predetermined overhead rate) - (actual hours x predetermined overhead rate), where standard hours for actual production = 100 hours

(100 x $15) - (110 x $15) = $150 unfavorable

Question 16

Brent Co. has intracompany service transfers from Division Core, a cost center, to Division Pro, a profit center. Under stable economic conditions, which of the following transfer prices is likely to be most conductive to evaluating whether both divisions have met their responsibilities?

A. Actual cost
B. Standard variable cost
C. Actual cost plus mark-up
D. Negotiated price

Answer 16

B. Standard variable cost

If actual cost is used, the selling division can pass on inefficiencies to the buying division. The same result would occur if actual cost plus a markup is used as the transfer price. Since the selling division is a cost center, negotiated price may not result in the most efficient transfer pricing due to inequities in negotiating power. Standard variable cost should be used since the selling division is a cost center and has no incentive to make a profit on the transfer. Furthermore, with standard variable costing, inefficiencies will not be passed on to the buying division, which is concerned with profits.

Question 17

The transfer price set by a parent or subsidiary for goods or services most likely can be used by multinational companies to

a. transfer as much of the cost as allowable to the country with the lowest overall tax burden
b. transfer funds from a subsidiary located in a strong-currency country to a subsidiary located in a country with depreciating currency.
c. transfer as much of the cost as allowable to the country with the highest overall tax burden.
d. change the financial statements of the individual subsidiaries

Answer 17

c. transfer as much of the cost as allowable to the country with the highest overall tax burden.

Transfer pricing is the price that is set for intercompany sales to encourage goal congruence among the division managers involved in the transfer.

Currently, most companies set transfer prices primarily to minimize overall corporate taxes.

Corporate taxes would be minimized if maximum profits are allocated to low-tax countries and minimal profits are allocated to high-tax countries. As such they would transfer as much of the cost as allowable to the country with a high tax rate so as to reduce the allocated profits to that country and reduce the tax burden.

Question 18

Financial data related to a company’s unit production for the current month are as follows:

• Standard overhead hours for production of 15,000 units: 20,000 hours
• Actual unit production: 15,000 units
• Actual variable factory overhead: $475,000
• Actual fixed factory overhead: $50,000
• Standard unit total overhead cost per hour: $30
• Standard fixed factory overhead per hour: $3

What amount is the company’s variable factory overhead variance for the current month?

a. ($75,000)
b. ($25,000)
c. $65,000
d. $125,000

Answer 18

c. $65,000

standard variable overhead per hour = (standard unit total overhead cost per hour- Standard fixed factory overhead per hour) = $30 - $3 = $27

Variable factory overhead variance:
= Total standard variable factory overhead cost - total actual variable factory overhead cost
= (standard hours for actual production x standard variable factory overhead per hour) - total actual variable factory overhead cost
= ($27 * 20,000) - $475,000 = $65,000 favorable

Question 19

The selection of the denominator in the return on investment (ROI) formula is critical to the measure’s effectiveness. Which denominator is criticized because it combines the effects of operating decisions made at one level of the organization with financing decisions made at another organizational level?

a. Total assets employed
b. Total assets available
c. Working capital plus other assets
d. Shareholders’ equity

Answer 19

d. Shareholders’ equity

The shareholders’ equity is influenced to some extent by the financing decisions made by the organization’s policymakers. Given a certain level of assets, if they chose to be a highly leveraged company, the shareholders’ equity will be relatively higher resulting in lower ROI. Hence, using shareholder’s equity as a base would affect operation results of one level because of financing decisions made at another organizational level.

Question 20

Under the two-variance method for analyzing factory overhead, the factory overhead applied to production is used in the computation of the

*controllable (budget) variance: yes/no
*Volume variance: yes/no

Answer 20

No, yes

the relationships in the two variance method of analyzing factory overhead are identified below:

actual factory overhead incurred – [controllable (budget) variance] – budget allowance based on standard hours – [volume variance] – factory overhead applied

the factory overhead applied to production is used only to compute the volume variance

Question 21

If a company follows a practice of isolating variances at the earlies point in time, what would be the appropriate time to isolate and recognize a direct material price variance?

a. when a purchase order is originated
b. when material is purchased
c. when material is used in production
d. when material is issued

Answer 21

b. when material is purchased

If the company follows a practice of isolating variances at the earliest point in time, a price variance will be isolated when identified, that is at purchase time. This is the earlies time at which the company knows that the actual price differs from the standard price.

Question 22

A company has two divisions. Division A has operating income of $500 and total assets of $1,000. Division B has operating income of $400 and total assets of $1,600. The required rate of return for the company is 10%. The company’s residual income would be which of the following amounts?

a. $0
b. $260
c. $640
d. $900

Answer 22

c. $640

Residual income is operating income less an imputed interest charge on average invested capital.

Residual income = operating income - [imputed interest rate x average invested capital]

Division A’s residual income is $500 - ($1,000 x 10%) = $400

Division B’s residual income is $400 - ($1,600 x 10%) = $240

Company-wide residual income is $400 + $240 = $640

Question 23

Relevant information for material A follows:

*actual quantity purchased: 6,500 lbs.
* Standard quantity allowed: 6,000 lbs.
* Actual price: $3.80
* Standard price: $4.00

What was the direct material quantity variance for material A?

a. $2,000 favorable
b. $1,900 favorable
c. $1,900 unfavorable
d. $2,000 unfavorable

Answer 23

d. $2,000 unfavorable

Direct material quantity variance is (actual quantity - standard quantity) x standard price.

Direct material quantity variance = (6,500-6,000) x $4.00 = $2,000. The variance is unfavorable since the actual quantity exceeds standard quantity.

Question 24

A department’s three-variance overhead standard costing system reported unfavorable spending and volume variances. The activity level selected for allocating overhead to the product was based on 80% of practical capacity. If 100% of practical capacity had been selected instead, how would the reported unfavorable spending and volume variances be affected?

increased/unchanged

• spending variance:
• volume variance:

Answer 24

• spending variance: unchanged
• volume variance: increased

The spending variance is NOT affected by the activity level selected for applying overhead because the computation of the spending variance involves the comparison of standard variable overhead costs and actual variable overhead costs, holding quantity constant at the actual quantity used.

The volume variance results when the actual activity level differs from the budgeted quantity used in determining the fixed overhead application rate. If the application rate had been based on 100% capacity rather than 80%, a lower application rate would have resulted. Because the volume variance was unfavorable at an 80% level of application, standard production must have been lower than 80% of capacity. The lower application rate based on 100% would have made the under-application of fixed costs even greater.