91 What is a static planning budget?

9-1 The planning budget is prepared for the planned level of activity. It is static because it is not adjusted even if
the level of activity subsequently changes.
92 What is a flexible budget and how does it differ from a static planning budget?
9-2 A flexible budget can be adjusted to reflect any level of activityincluding the actual level of activity. By
contrast, a static planning budget is prepared for a single level of activity and is not subsequently adjusted.
93 What are some of the possible reasons that actual results may differ from what had been budgeted at the
beginning of a period?
9-3 Actual results can differ from the budget for many reasons. Very broadly speaking, the differences are usually
due to a change in the level of activity, changes in prices, and changes in how effectively resources are managed.
94 Why is it difficult to interpret a difference between how much expense was budgeted and how much was
actually spent?
9-4 As noted above, a difference between the budget and actual results can be due to many factors. Most importantly,
the level of activity can have a very big impact on costs. From a managers perspective, a variance that is due to a change
in activity is very different from a variance that is due to changes in prices and changes in how effectively resources are
managed. A variance of the first kind requires very different actions from a variance of the second kind. Consequently,
these two kinds of variances should be clearly separated from each other. When the budget is directly compared to the
actual results, these two kinds of variances are lumped together.
95 What is an activity variance and what does it mean?
9-5 An activity variance is the difference between a revenue or cost item in the flexible budget and the same item
in the static planning budget. An activity variance is due solely to the difference in the actual level of activity used in
the flexible budget and the level of activity assumed in the planning budget. Caution should be exercised in interpreting
an activity variance. The favorable and unfavorable labels are perhaps misleading for activity variances that involve
costs. A favorable activity variance for a cost occurs because the cost has some variable component and the actual
level of activity is less than the planned level of activity. An unfavorable activity variance for a cost occurs because
the cost has some variable component and the actual level of activity is greater than the planned level of activity.
96 What is a revenue variance and what does it mean?
9-6 A revenue variance is the difference between the actual revenue for the period and how much the revenue should
have been, given the actual level of activity. A revenue variance is easy to interpret. A favorable revenue variance occurs
because the revenue is greater than expected for the actual level of activity. An unfavorable revenue variance occurs
because the revenue is less than expected for the actual level of activity.
97 What is a spending variance and what does it mean?
9-7 A spending variance is the difference between the actual amount of the cost and how much a cost should have
been, given the actual level of activity. Like the revenue variance, the interpretation of a spending variance is straight-
forward. A favorable spending variance occurs because the cost is lower than expected for the actual level of activity.
An unfavorable spending variance occurs because the cost is higher than expected for the actual level of activity.
98 What does a flexible budget performance report do that a simple comparison of budgeted to actual results
does not do?
9-8 In a flexible budget performance report, the actual results are not directly compared to the static planning budget.
The flexible budget is interposed between the actual results and the static planning budget. The differences between the
flexible budget and the static planning budget are activity variances. The differences between the actual results and the
flexible budget are the revenue and spending variances. The flexible budget performance report cleanly separates the
differences between the actual results and the static planning budget that are due to changes in activity (the activity
variances) from the differences that are due to changes in prices and the effectiveness with which resources are managed
(the revenue and spending variances).
99 How does a flexible budget based on two cost drivers differ from a flexible budget based on a single cost
driver?
9-9 The only difference between a flexible budget based on a single cost driver and one based on two cost drivers
is the cost formulas. When there are two cost drivers, some costs may be a function of the first cost driver, some costs
may be a function of the second cost driver, and some costs may be a function of both cost drivers.
910 What assumption is implicitly made about cost behavior when actual results are directly compared to a
static planning budget? Why is this assumption questionable?
9-10 When actual results are directly compared to the static planning budget, it is implicitly assumed that costs (and
revenues) should not change with a change in the level of activity. This assumption is valid only for fixed costs.
However, it is unlikely that all costs are fixed. Some are likely to be variable or mixed.
911 What assumption is implicitly made about cost behavior when all of the items in a static planning budget
are adjusted in proportion to a change in activity? Why is this assumption questionable?
9-11 When the static planning budget is adjusted proportionately for a change in activity and then directly compared
to actual results, it is implicitly assumed that costs should change in proportion to a change in the level of activity. This
assumption is valid only for strictly variable costs. However, it is unlikely that all costs are strictly variable. Some are
likely to be fixed or mixed.

101 What is a quantity standard? What is a price standard?

10-1 A quantity standard indicates how much of an input should be used to make a unit of output. A price standard
indicates how much the input should cost.
102 Why are separate price and quantity variances computed?
10-2 Separating an overall variance into a price variance and a quantity variance provides more information.
Moreover, price and quantity variances are usually the responsibilities of different managers.
103 Who is generally responsible for the materials price variance? The materials quantity variance? The labor
efficiency variance?
10-3 The materials price variance is usually the responsibility of the purchasing manager. The materials quantity and
labor efficiency variances are usually the responsibility of production managers and supervisors.
104 The materials price variance can be computed at what two different points in time? Which point is better?
Why?
10-4 The materials price variance can be computed either when materials are purchased or when they are placed into
production. It is usually better to compute the variance when materials are purchased because that is when the purchasing
manager, who has responsibility for this variance, has completed his or her work. In addition, recognizing the price
variance when materials are purchased allows the company to carry its raw materials in the inventory accounts at
standard cost, which greatly simplifies bookkeeping.
105 If the materials price variance is favorable but the materials quantity variance is unfavorable, what might
this indicate?
10-5 This combination of variances may indicate that inferior quality materials were purchased at a discounted price,
but the low-quality materials created production problems.
106 Should standards be used to identify who to blame for problems?
10-6 If standards are used to find who to blame for problems, they can breed resentment and undermine morale.
Standards should not be used to find someone to blame for problems.
107 Our workers are all under labor contracts; therefore, our labor rate variance is bound to be zero. Discuss.
10-7 Several factors other than the contractual rate paid to workers can cause a labor rate variance. For example,
skilled workers with high hourly rates of pay can be given duties that require little skill and that call for low hourly rates
of pay, resulting in an unfavorable rate variance. Or unskilled or untrained workers can be assigned to tasks that should
be filled by more skilled workers with higher rates of pay, resulting in a favorable rate variance. Unfavorable rate
variances can also arise from overtime work at premium rates.
108 What effect, if any, would you expect poor-quality materials to have on direct labor variances?
10-8 If poor quality materials create production problems, a result could be excessive labor time and therefore an
unfavorable labor efficiency variance. Poor quality materials would not ordinarily affect the labor rate variance.
109 If variable manufacturing overhead is applied to production on the basis of direct laborhours and the direct
labor efficiency variance is unfavorable, will the variable overhead efficiency variance be favorable or
unfavorable, or could it be either? Explain.
10-9 If overhead is applied on the basis of direct labor-hours, then the variable overhead efficiency variance and the
direct labor efficiency variance will always be favorable or unfavorable together. Both variances are computed by
comparing the number of direct labor-hours actually worked to the standard hours allowed. That is, in each case the
formula is:
Efficiency variance = SR(AH SH)
Only the SR part of the formula, the standard rate, differs between the two variances.
1010 Why can undue emphasis on labor efficiency variances lead to excess work in process inventories?
10-10 If labor is a fixed cost and standards are tight, then the only way to generate favorable labor efficiency variances
is for every workstation to produce at capacity. However, the output of the entire system is limited by the capacity of
the bottleneck. If workstations before the bottleneck in the production process produce at capacity, the bottleneck will
be unable to process all of the work in process. In general, if every workstation is attempting to produce at capacity,
then work in process inventory will build up in front of the workstations with the least capacity.

111 What is meant by the term decentralization?

11-1 In a decentralized organization, decision-making authority isnt confined to a few top executives; instead,
decision-making authority is spread throughout the organization.
112 What benefits result from decentralization?
11-2 The benefits of decentralization include: (1) by delegating day-to-day problem solving to lower-level managers,
top management can concentrate on bigger issues such as overall strategy; (2) empowering lower-level managers to
make decisions puts decision-making authority in the hands of those who tend to have the most detailed and up-to-date
information about day-to-day operations; (3) by eliminating layers of decision-making and approvals, organizations can
respond more quickly to customers and to changes in the operating environment; (4) granting decision-making authority
helps train lower-level managers for higher-level positions; and (5) empowering lower-level managers to make decisions
can increase their motivation and job satisfaction.
113 Distinguish between a cost center, a profit center, and an investment center
11-3 The manager of a cost center has control over cost, but not revenue or the use of investment funds. A profit
center manager has control over both cost and revenue. An investment center manager has control over cost and revenue
and the use of investment funds. Examples of cost centers include the human resource department, the IT department,
the accounting department, an example of a profit center is the selling or sales department, the corporate headquarters
or division in a large decentralized organization would be an example of an investment center.
116 In what way can the use of ROI as a performance measure for investment centers lead to bad decisions?
How does the residual income approach overcome this problem?
11-6 If ROI is used to evaluate performance, a manager of an investment center may reject a profitable investment
opportunity whose rate of return exceeds the companys required rate of return but whose rate of return is less than the
investment centers current ROI. The residual income approach overcomes this problem because any project whose rate
of return exceeds the companys minimum required rate of return will result in an increase in residual income.
117 What is the difference between delivery cycle time and throughput time? What four elements make up
throughput time? What elements of throughput time are value-added and what elements are nonvalue-added?
11-7 The difference between delivery cycle time and throughput time is the waiting period between when an order is
received and when production on the order is started. Throughput time is made up of process time, inspection time,
move time, and queue time. Process time is value-added time and inspection time, move time, and queue time are non-
value-added time.
118 What does a manufacturing cycle efficiency (MCE) of less than 1 mean? How would you interpret an MCE
of 0.40?
11-8 An MCE of less than 1 means that the production process includes non-value-added time. An MCE of 0.40, for
example, means that 40% of throughput time consists of actual processing, and that the other 60% consists of moving,
inspection, and other non-value-added activities.
119 Why do the measures used in a balanced scorecard differ from company to company?
11-9 A companys balanced scorecard should be derived from and support its strategy. Because different companies
have different strategies, their balanced scorecards should be different.
1110 Why does the balanced scorecard include financial performance measures as well as measures of how well
internal business processes are doing?
11-10 The balanced scorecard is constructed to support the companys strategy, which is a theory about what actions
will further the companys goals. Assuming that the company has financial goals, measures of financial performance
must be included in the balanced scorecard as a check on the reality of the theory. If the internal business processes
improve, but the financial outcomes do not improve, the theory may be flawed and the strategy should be changed.

121 What is a relevant cost?

12-1 A relevant cost is a cost that differs in total between the alternatives in a decision.
122 Define the following terms: incremental cost, opportunity cost, and sunk cost
12-2 An incremental cost (or benefit) is the change in cost (or benefit) that will result from some proposed action.
An opportunity cost is the benefit that is lost or sacrificed when rejecting some course of action. A sunk cost is a cost
that has already been incurred and that cannot be changed by any future decision.
123 Are variable costs always relevant costs? Explain.
12-3 No. Variable costs are relevant costs only if they differ in total between the alternatives under consideration.
124 Sunk costs are easy to spottheyre the fixed costs associated with a decision. Do you agree? Explain.
12-4 No. Not all fixed costs are sunkonly those for which the cost has already been irrevocably incurred. A variable
cost can be a sunk cost if it has already been incurred.
125 Variable costs and differential costs mean the same thing. Do you agree? Explain.
12-5 No. A variable cost is a cost that varies in total amount in direct proportion to changes in the level of activity.
A differential cost is the difference in cost between two alternatives. If the level of activity is the same for the two
alternatives, a variable cost will not be affected and it will be irrelevant.
126 All future costs are relevant in decision making. Do you agree? Why?
12-6 No. Only those future costs that differ between the alternatives are relevant.
127 Prentice Company is considering dropping one of its product lines. What costs of the product line would be
relevant to this decision? What costs would be irrelevant?
12-7 Only those costs that would be avoided as a result of dropping the product line are relevant in the decision.
Costs that will not be affected by the decision are irrelevant.
128 If a product is generating a loss, then it should be discontinued. Do you agree? Explain.
12-8 Not necessarily. An apparent loss may be the result of allocated common costs or of sunk costs that cannot be
avoided if the product is dropped. A product should be discontinued only if the contribution margin that will be lost as
a result of dropping the product is less than the fixed costs that would be avoided. Even in that situation the product may
be retained if it promotes the sale of other products.
129 What is the danger in allocating common fixed costs among products or other segments of an organization?
12-9 Allocations of common fixed costs can make a product (or other segment) appear to be unprofitable, whereas
in fact it may be profitable.
1210 How does opportunity cost enter into a make or buy decision?
12-10 If a company decides to make a part internally rather than to buy it from an outside supplier, then a portion of
the companys facilities have to be used to make the part. The companys opportunity cost is measured by the benefits
that could be derived from the best alternative use of the facilities.
1211 Give at least four examples of possible constraints.
12-11 Any resource that is required to make products and get them into the hands of customers could be a constraint.
Some examples are machine time, direct labor time, floor space, raw materials, investment capital, supervisory time,
and storage space. While not covered in the text, constraints can also be intangible and often take the form of a formal
or informal policy that prevents the organization from furthering its goals.
1212 How will relating product contribution margins to the amount of the constrained resource they consume
help a company maximize its profits?
12-12 Assuming that fixed costs are not affected, profits are maximized when the total contribution margin is
maximized. A company can maximize its total contribution margin by focusing on the products with the greatest amount
of contribution margin per unit of the constrained resource.
1214 From a decision-making point of view, should joint costs be allocated among joint products?
12-14 Joint costs should not be allocated among joint products for decision-making purposes. If joint costs are
allocated among the joint products, then managers may think they are avoidable costs of the end products. However, the
joint costs will continue to be incurred as long as the process is run regardless of what is done with one of the end
products. Thus, when making decisions about the end products, the joint costs are not avoidable and are irrelevant.
1215 What guideline should be used in determining whether a joint product should be sold at the split-off point
or processed further?
12-15 If the incremental revenue from further processing exceeds the incremental costs of further processing, the
product should be processed further.
1216 Airlines sometimes offer reduced rates during certain times of the week to members of a businesspersons
family if they accompany him or her on trips. How does the concept of relevant costs enter into the decision by
the airline to offer reduced rates of this type?
12-16 Most costs of a flight are either sunk costs, or costs that do not depend on the number of passengers on the flight.
Depreciation of the aircraft, salaries of personnel on the ground and in the air, and fuel costs, for example, are the same
whether the flight is full or almost empty. Therefore, adding more passengers at reduced fares when seats would
otherwise be empty does little to increase the total costs of operating the flight, but increases the total contribution and
total profit.