Chapter 10 – Performance Evaluation

Pages 583-590, 603-508

10.1

Decentralization
 Organizations split their operations into different operating
segments
 Top management delegates decision-making responsibility to the
segment managers

ABC Corp.
CEO

Appliance Electronics Consumer Goods

Division Division Division

Televisions DVD Players CD Players

Production Sales

 Advantages
o Frees top management’s time
o Use of expert knowledge
o Improves customer relations
o Provides training
o Improves motivation and retention

 Disadvantages
o Duplication of costs
o Potential problems achieving goal congruence
 Goal congruence – when individual goals are in
agreement with organizational goal
Performance Evaluation
 Provide upper management with feedback
 To be effective, should
o Clearly communicate expectations
o Provide benchmarks that promote goal congruence
and coordination between segments
o Motivate segment managers

Responsibility Accounting
 Responsibility Center
o part of an organization whose manger is accountable for
planning and controlling activities

 Responsibility Accounting
o system for evaluating performance of each responsibility
center and its manger.

Responsibility Centers

Cost center - managers are accountable for costs only

 production department, human resources
department, etc.
 performance measured by comparing actual costs
to budgeted costs

Revenue center - managers are accountable primarily for revenues

 sales territories
 performance measured by comparing actual revenues
to the budget

Profit center - managers are accountable for both revenues and costs
 chain of stores, restaurants, etc.
 performance measured by comparing actual revenues,
expenses, and profits to the budget

Investment center - managers are responsible for 1) generating revenues,

2) controlling costs, and 3) efficiently managing the division’s
assets
 large division of a corporation
 treated as if they were standalone companies
10.2

Performance Report
 compares actual revenues and expenses to budgeted figures
 Variance – difference between actual and budget

o Favorable variance: causes operating income to be higher

than budgeted

o Unfavorable variance: causes operating income to be lower

than budgeted

 Management by exception
o Investigate variances

1. What type of responsibility center is the subunit?

Revenue center
2. Which items should be investigated if management investigates all
variances exceeding $200,000 or 5%?

3. Should only unfavorable variances be investigated? Explain.

4. Variance %= variance amount/budgeted amount

Segment Margin
 Operating income generated by a profit or investment center before
subtracting common allocated fixed costs

 Controllable vs. Uncontrollable Variances

o Managers should only be held responsible for variance they
can control

Caldrone Industries has entered the information for the most recent year for its
pharmaceutical segment in the performance report below.

Budgeted data for the same period was as follows:

Budgeted sales in units 8,000
Budgeted average selling price per unit $100
Variable cost of goods sold per unit $25
Variable operating expenses per unit $20
Direct fixed Manufacturing Overhead (manager held accountable) $80,000
Direct Fixed Operating Expenses (manager held accountable) 21,000
Common Fixed Expenses Allocated to the Pharmaceutical Segment 18,000

Complete the following report. Round percentages to the nearest hundredth.

Performance Report
 Caldrone Industries - Pharmaceutical Segment
For Fiscal Year Ending December 31
(all data is in millions)

8,600* 8,000*
$102.32 $100.00
Actual Budgeted Variance Variance %
Sales $880,000 $800,000 $80,000F 10%
Less Variable Expenses:
Variable Cost of Goods Sold 204,000 $200,000 $4,000U 2%
Variable Operating Expenses 153,600 $160,000 $6,400F 4%
Contribution Margin 522,400 $440,000 $82,400F 18.73%
Less Direct Fixed Expenses:
Fixed Manufacturing 86,400
Overhead $80,000 $6,400U 8%
Fixed Operating Expenses 22,050 $21,000 $1,050U 5%
Segment Margin 413,950
(manager held accountable) $339,000 $74,950F 22.11%
Less Common Fixed
Expenses 19,080 $18,000 $1,080 6%
Operating Income $394,870 $321,000 $73,870F 23.01%

10.4

Static Budget
 prepared for one level of sales volume
 the master budget from Chapter 9 was static

Variance
 difference between actual results and the budget
 labeled as Favorable or Unfavorable

Favorable
 actual revenues > budgeted revenues
 actual expenses < budgeted costs

Unfavorable
 actual revenues < budgeted revenues
 actual expenses > budgeted expenses
Flexible Budgets
 summarized budgets prepared for different levels of
volume
 using the cost behavior identified in the static master budget
 important when a company has significant variable expenses
o volume increases total variable expenses increase.
o Using a static budget would result in Unfavorable variable
expense variances
 Used to plan for future periods and to evaluate performance after
the period has ended (control)

Planning

Using flexible budget for planning purposes:

 Shows how revenues and expenses should vary as the number of
products sold varies
 Allows “what if” analysis
 Must know cost behavior:
o Total fixed costs will be the same regardless of volume as
long as the volume is within the same relevant range
o Total variable costs will change as volume changes.

Performance Evaluation

Use flexible budgets at the end of the period to

 evaluate the company’s financial performance
 help control costs

Compare the actual results against the flexible budget for the actual
volume

Master Budget Variance – overall difference between

Master budget and actual results

Master Budget minus Actual Results

Can be explained by the following:
Volume Variance - arises only because the number of units actually
sold differs from the original volume in the master budget

Master Budget minus Flexible Budget

Flexible Budget Variance- due to factors other than volume

Flexible Budget minus Actual Results

Variances should be expressed as ABSOLUTE numbers with:

 F OR FAVORABLE
 U FOR UNFAVORABLE

Master Budget Variance

Flexible Budget Variance Volume Variance

Actual Flexible Budget Master Budget

Main Street Muffins sell its muffins for an average price of $25 per case. The
following is the budget information for this year:
Budgeted sales in cases 8,000 cases
Cost of muffins per case $10
Packaging costs per case $1
Shipping expense per case $ 3
Sales commission per case 2% of sales price
Salaries expense $6,200
Office rent $3,500
Depreciation $2,500
Insurance $1,900
Office supplies $900
 The company actual sold 8,300 cases resulting in total sales revenue of
$215,400. Actual expenses were as follows:

Cost of muffins $74,700

Packaging costs 8,700
Shipping expense 25,900
Sales commissions 4,308
Salaries expense 6,900
Office rent 3,500
Depreciation 2,500
Insurance 1,800
Office supplies 1,200

Prepare the budget performance report:

Main Street Muffins

Master Budget Performance Report - Sales and Operating Expenses
For Year Ended December 31
Flexible
Budget Flexible Volume Master
  Actual Variance Budget Variance Budget
8,300 8,000
  8,300 cases cases cases
Sales Revenue $215,400 $7,900F $207,500 $7,500F $200,000
Variable Expenses: $25
Cost of Goods $74,700 $8,300F $83,000 $3,000U $80,000
Packaging Expense
Shipping Expense
Sales Commissions
Total Variable Expenses
Contribution Margin
Fixed Expenses:
Salaries
Office Rent
Depreciation
Insurance
Office Supplies
Total Fixed Expenses
Operating Income
Zany Brainy projected current year sales of 50,000 units at a unit sale price of $20.00. Actual
current year sales were 55,000 units at $22.00 per unit. Actual variable costs, budgeted at $14.00
per unit, totaled $15.00 per unit. Budgeted fixed costs totaled $400,000, while actual fixed costs
amounted to $420,000.
Actual: 55,000 units sold for $22 each= 1,210,000
Flexible Budget:$55,000*$20 each
Master Budget: 50,000 units expected to sell*$20 each= 1,000,000
210,000F

What is the volume variance for total revenue? Difference between 55,000*$20 and 50,000*$20
A. $110,000 favorable
B. $100,000 unfavorable
C. $110,000 unfavorable
D. $100,000 favorable

What is the flexible budget variance for variable expenses? Difference between 55,000*15 and
55,000*14
Actual: 55,000*15
Flexible:55,000*14
Master: 50,000*14
A. $55,000 favorable
B. $50,000 favorable
C. $55,000 unfavorable
D. $50,000 unfavorable

What is the flexible budget variance for total expenses?

Actual:
Flexible
A. $55,000 unfavorable
B. $75,000 unfavorable
C. $55,000 favorable
D. $75,000 favorable