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Chapter Fifteen
Performance Evaluation
© 2015 McGraw-Hill Education.
An accounting system thatprovides information . . .
Responsibility Accounting
Relating to theresponsibilities of
individual managers.
To evaluatemanagers on
controllable items.
15-2
Decentralization
Improves qualityof decisions.
Encourages upper-level management toconcentrate on strategic decisions.
Improvesproductivity.
Developslower-levelmanagers.
Improvesperformanceevaluation.
Advantages
15-3
Responsibility Centers
Investment Center
Profit Center
Cost Center
15-4
CostCenter
ProfitCenter
InvestmentCenter
Evaluation Measures
Profitability
Return on investment (ROI) Residual income (RI)
Cost controlQuantity and qualityof services
Managerial Performance Measurement
15-5
Since the exercise of control may be clouded,managers are usually held responsible for items
over which they have predominant ratherthan absolute control.
Since the exercise of control may be clouded,managers are usually held responsible for items
over which they have predominant ratherthan absolute control.
I’m in control
Controllability Concept
Managers shouldonly be evaluated on
revenues or coststhey control.
15-6
Preparing Flexible Budgets
The master budget, sometimes called a static budget, is based solely on the planned volume of activity. Flexible budgets differ from static budgets in that they show expected revenues
and costs at a variety of volume levels.
15-7
Determining Variances for Performance Evaluation
The differences between standard and actual amounts are called variances. A variance may be favorable or unfavorable. When actual sales are
less than expected, an unfavorable sales variance exists. When actual sales revenue is greater than
expected revenue, a company has a favorable sales variance.
The differences between standard and actual amounts are called variances. A variance may be favorable or unfavorable. When actual sales are
less than expected, an unfavorable sales variance exists. When actual sales revenue is greater than
expected revenue, a company has a favorable sales variance.
15-8
Determining Variances for Performance Evaluation
Variances are not limited to the evaluation of revenues. They can also be used to understand
the differences between standard and actual amounts of costs. When actual costs are less
than standard costs, cost variances are favorable because lower costs increase net income.
Unfavorable cost variances exist when actual costs are more than standard costs.
Variances are not limited to the evaluation of revenues. They can also be used to understand
the differences between standard and actual amounts of costs. When actual costs are less
than standard costs, cost variances are favorable because lower costs increase net income.
Unfavorable cost variances exist when actual costs are more than standard costs.
15-9
Sales Volume VariancesThe difference between the static budget sales amount and the flexible budget sales amount is a measure of
the sales volume variance.Exhibit 15.2Melrose Manufacturing Company’s Volume Variances
15-10
Interpreting the Volume Variances
In a standard cost system, marketing managers are usually responsible for the volume variance. Because sales volume drives production, production managers
have little control over volume variance.
In the case of Melrose, the marketing manager exceeded planned sales volume by 1,000 units, resulting in an
$80,000 favorable revenue variance ($80 × 1,000). The unfavorable cost variances are somewhat misleading.
Melrose incurred higher costs because it manufactured and sold more units than planned.
15-11
Fixed Cost Considerations
The fixed costs are the same in both the static and flexible budgets.
Spending VarianceThe difference between the
budgeted fixed costs and the actual
fixed costs
Fixed Cost Volume Variance
The difference between costs
at planned volume versus
actual volume
15-12
Flexible Budget Variances
For effective performance evaluation, management must compare the actual results achieved to the flexible
budget based on the actual volume of activity. Here is a comparison of the standard amount and actual amount
per unit for the current period for Melrose.Standard Actual
Sales price 80.00$ 78.00$ Variable material cost 12.00 11.78 Variable labor cost 16.80 17.25 Variable overhead cost 5.60 5.75 Variable GS&A cost 15.00 14.90
15-13
Calculating Sales Price Variance
Actual sales (19,000 × $78) 1,482,000$ Expected sales (18,000 × $80) 1,440,000 Favorable total sales variance 42,000$
Activity variance (volume) 80,000$ FSales price variance (38,000) UFavorable total sales variance 42,000$ F
or
15-14
The Human Element Associated with Flexible Budget Variances
• The flexible budget cost variances offer insight into management efficiency.
• As with sales variances, cost variances require careful analysis.
• A favorable materials variance could mean that purchasing agents are good negotiators or it might be caused by paying low prices for inferior goods.
15-15
The vice president of operations receives summarized information
from each unit.
Management by exception
Upper-level management does not receive operating
detail unless problems arise.
Management focuses on areas not performing as expected.
Management by Exception
Businesses cannot afford to have
managers spend large amounts of
time on operations that function
normally. 15-16
Return on Investment
Return on investment is the ratio of income to the investment used to
generate the income.
ROI = Operating IncomeOperating Assets
15-17
Return on Investment
LumberManufacturing
Home Building
Furniture Manufacturing
=
=
=
$60,000$300,000
$46,080$256,000
$81,940$482,000
= 20%
= 18%
= 17%All other things being equal,
higher ROIs indicate better performance. 15-18
ROI = Operating IncomeOperating Assets
MarginMargin TurnoverTurnover
Factors Affecting ROI
ROI = ×Sales
Operating AssetsOperating Income
Sales
15-19
Factors Affecting ROI
Three ways to improve ROI
1 Increase Sales
2 Reduce Expenses
3 Reduce Operating Assets
(The investment base)
15-20
Residual Income Operating Income– Investment charge = Residual income
Operating Assets× Desired ROI = Investment charge
Investment center’scost of acquiring
investment capital
15-21
Residual Income
Residual income encourages managers to make profitable investments that would
be rejected by managers using ROI.
Suboptimization occurs with ROI when managers
benefit themselves at the expense of the company
15-22
End of Chapter Fifteen
15-23