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Income statement refers to the financial statement which records the revenues and expenses of any company for the considered period. It is accrued in nature having captured even some of the non-cashflow incurring events like depreciation, receivables and payables. (Accounting Coach, NA)
Income statement helps in assessing the financial performance of the company during the period along with its profit margins. The key particulars of income statement include Sales Revenues, Cost of Sales, Selling & Administrative expenses, and Net Income. The income statement prepared for the Russel Income based on the data given is as below:
| Russel Company | |
| Income Statement for June 20X5 | |
| Particulars | in $ |
| Sales | 800,000 |
| Total Sales | 800,000 |
| Direct Materials used | 200,000 |
| Plant wages | 140,000 |
| Insurance, factory | 4,000 |
| Maintenance, factory | 28,000 |
| Utilities, factory | 16,000 |
| Cost of Sales | 388,000 |
| Gross Profit | 412,000 |
| Selling expenses | 60,000 |
| Office salaries | 80,000 |
| Selling & Admin Expenses | 140,000 |
| Operating Profit (EBITDA) | 272,000 |
| Depreciation, factory | 24,000 |
| EBIT (Earnings Before Interest & Taxes) | 248,000 |
| Interest Cost | 0 |
| PBT (Profit Before Tax) | 248,000 |
| Taxes | 0 |
| PAT (Profit After Tax) | 248,000 |
Balance Sheet refers to the financial statement that records financial position of the company as on the period considered. The financial position of the company includes assessment of the capital assets of the company and its sources of funds through liabilities and retained earnings. It even captures the assets and liabilities at the current or immediate level. The key particulars of balance sheet include Current Assets, Fixed Assets, Current Liabilities, Fixed Liabilities and Retained Earnings. (Accounting Tools, NA)
| Russel Company | |
| Balance Sheet for June 20X5 | |
| ASSETS | in $ |
| Cash | 56,000 |
| Inventories, factory | 180,000 |
| Accounts receivables | 100,000 |
| Current Assets | 336,000 |
| Equipment, net | 240,000 |
| Buildings, net | 400,000 |
| Net Fixed Assets | 640,000 |
| TOTAL ASSETS | 976,000 |
| LIABILITIES & EQUITY | in $ |
| Accounts payables | 40,000 |
| Bonds payables | 160,000 |
| Current Liabilities | 200,000 |
| Capital Stock | 400,000 |
| TOTAL LIABILITIES | 600,000 |
| Retained Earnings | 376,000 |
| TOTAL LIABILITIES & EQUITY | 976,000 |
How do we use computer-based budgeting in sensitivity analysis?
Computer based budgeting in sensitivity analysis is an assistance provided to perform so called “what-if” analysis using financial planning models. (Unnibhavi, 2005)
Sensitivity analysis refers to the technique where in analysis is conducted by observing the change in the output results by varying input data or assumptions. In general a computer based MS-Excel model would be developed based on the inputs and the changes in the output under different scenarios by changing the input assumptions is recorded and the results are analyzed to predict the movement or variations in the outputs.
For example, in the above two questions, income statement and balance sheet are prepared and net profit, retained earnings are computed based on the given input financial data for the Russel Company for the period considered June 30, 20X5. Different scenarios may be considered by varying the sales in the income statement and the Capital stock in the balance statement and accordingly PAT in the income statement would vary and Retained Earnings in the Balance sheet would vary. These variations are observed and assessed using computer based sensitivity analysis. (Pearson Education, 2015)
Explain how the choice of the type of responsibility center affects managers’ behaviour.
Responsibility Center refers to the sub-system which may be a sector or a segment or a department of any organization where in an accountable manager has been appointed to control the set of accounting practices under each responsibility center.
Each responsibility center accounts for financial planning, financial budgeting, financial results for the respective segments or departments and this entire process is combined to form a Responsibility Accounting System. (Simanovsky, 2010)
The type of responsibility centers are considered under four levels which include:
Cost is chosen to account for all costs or expense related activities only. In this managers are only held accountable for cost that is incurred and not for revenues. They are responsible for cost that can be controlled by them or people working under them.
Revenue center manager is made accountable for all sorts of revenue streams from sales of products/ services including any receivables during the accounting period.
Third level of responsibility center is recorded for Profit. The manager is Profit center has power to take decisions that can impact both costs and revenue and hence profit for the division. (Hussey, 2010)
Fourth level of responsibility center is made for the Investments. Managers looking after investment center have more power in comparison to cost and revenue center manager because they have control over expenditures, revenues and money that can be utilized in centre’s assets.
Thus it can be seen that four levels of responsibility centers affect managers’ behavior.
2. Given, data of Alex Miller Corporation’s Flashlight Division and Nightlight division related to Lamp usage and Flash usage are compiled as per attached MS –Excel sheet q2.Based on the given data, applying single rate and dual rate methods, the total cost for Lamp and Flash usage are derived as below:
If a single-rate cost-allocation method is used, what amount of operating costs will be budgeted?
For the Lamp Division each month?
For the Flashlight Division each month?
| Single Rate |
|
| Practical Capacity | 20,000 |
| Fixed Cost | 2,40,000 |
| Fixed Cost per hour | 12 |
| Variable Cost per hour | 10 |
| Single Rate Cost per hour | 22 |
| Lamp Division usage per month | 800 |
| Lamp Division cost per month | 17600 |
| Flash Division usage per month | 450 |
| Flash Division cost per month | 9900 |
For the month of June, if a single-rate cost-allocation method is used, what amount of cost will be allocated?
To the Lamp Division?
To the Flashlight Division?
Assume actual usage is used to allocate operating costs.
| For the month of June |
|
| Single Rate Cost per hour | 22 |
| Lamp Division usage per month | 700 |
| Lamp Division cost per month (Usage x Cost) | 15400 |
| Flash Division usage per month | 400 |
| Flash Division cost per month (Usage x Cost) | 8800 |
If a dual-rate cost-allocation method is used, what amount of operating costs will be budgeted?
For the Lamp Division each month?
For the Flashlight Division each month?
Fixed costs $240,000 / 20,000 practical capacity hours = $12 / hour
Budgeted costs - Lamp Division
(800 x $12 / hour) + (800 x $10/hour) = $17,600 per month
Budgeted costs - Flashlight Division
(450 x $12 / hour) + (450 x $10/hour) = $9,900 per month
For the month of June, if a dual-rate cost-allocation method is used, what amount of cost will be allocated?
To the Lamp Division?
To the Flashlight Division?
Assume budgeted usage is used to allocate fixed operating costs and actual usage is used to allocate variable operating costs.
| Dual Rate- for month of June |
|
| Fixed Cost per year | 2,40,000 |
| Practical Capacity per year | 20000 |
| Fixed Cost per hour | 12 |
| Variable operations costs per hour | 10 |
| Budgeted usage of Lamp division each month | 800 |
| Actual usage of Lamp division during month of June | 700 |
| Fixed Costs for Lamp division each month | 9600 |
| Variable Operations costs for Lamp division for the month of June | 7000 |
| Total cost for Lamp Division for the month of June | 16600 |
| Budgeted usage of Flash division each month | 450 |
| Actual usage of Flash division during month of June | 400 |
| Fixed Costs for Flash division each month | 5400 |
| Variable Operations costs for Flash division for the month of June | 4000 |
| Total cost for Flash Division for the month of June | 9400 |
Explain which method is the most practical?
Dual Rate Method is more practical as it computes costs or charges based on actual usage.
3. Given, Oregon Lumber product details with their split off points and ending inventory as attached in the MS Excel sheet q3.It is also provided that beginning inventory is zero and the joint costs of processing in January $ 280,000.
Determine the value of ending inventory if the sales value at split off method is used for product costing.
Considering the split off method for product costing, the allocated costs for the products at the given joint cost of $ 280,000 is as below: (Carey, et al., 2014)
| Product | Board feet | Split off Price/ board foot | Sale Value | % | Joint Cost in Jan | Allocated cost |
| 2 x 4's | 60,00,000 | 0.30 | 1800000 | 45.00% | 280000 | 126000 |
| 2 x 6's | 30,00,000 | 0.40 | 1200000 | 30.00% | 280000 | 84000 |
| 4 x 4's | 20,00,000 | 0.45 | 900000 | 22.50% | 280000 | 63000 |
| Slabs | 10,00,000 | 0.10 | 100000 | 2.50% | 280000 | 7000 |
| 4000000 | 280000 |
Considering the given ending inventory position and the ending inventory values are:
| Product | Board feet (bf) | Allocated cost | Ending Inventory (EI) in bf | EI % | EI Value |
| 2 x 4's | 60,00,000 | 126000 | 500000 | 8.333% | 10500 |
| 2 x 6's | 30,00,000 | 84000 | 250000 | 8.333% | 7000 |
| 4 x 4's | 20,00,000 | 63000 | 100000 | 5.000% | 3150 |
| Slabs | 10,00,000 | 7000 | 50000 | 5.000% | 350 |
| 280000 | 21000 |
Thus, the value of ending inventory as determined above is $ 21,000.
Can you explain how the Silver Company might change its accounting system to reflect the reporting problems better? Are there other problems with the purchasing area?
As mentioned in the case the company has adopted to estimate cost of production for each batch of production separately including all the process. It is noted that there is a deviation in the cost price even till the retail value of some of the products of the Company in the recent times. As observed the deviations are due to the special extraction process involved by adopting different methods from different parts of the world.
Though the reason is genuine, the high variation in price or cost of production should not be reflected in the manner it was shown because the process adopted may vary but end product of all batches remain same and thus should be distributed evenly among all the batches of production. This can be made possible by considering Joint cost. (Jennings, 2001)
Joint cost category may be formed and computed by considering all the costs for the production under this category and distributing this cost over the total production of finished goods rather than only a set of goods considered as the extract of this high cost process used for a set of batch has been later used easily for next set at a lower cost. Thus considering a Joint cost category and modifying the accounting system accordingly would streamline the process of reporting and also be effective in understanding the actual cost of production per product. (Pratt, 2010)
Problems may be considered with the purchasing department as they have to make the accounting team understand the process and accordingly should inform them to create the categories as they are the technical persons who are involved in the process. Since this has not happened, may be the Company should consider to check if technical experts are there in the purchasing team, if not, they should hire some so that in future the problems are not technically resolved and accounting personnel are made understood of the process and make the reporting effectively.
(Baker, 2015)
4. An examination of the cost records of the Wilson River P/L indicates that the materials price variance is favorable but that the materials efficiency variance is unfavorable by a substantial amount. What might this indicate? Explain using examples to support your statements.
Direct Materials Price Variance is computed by measuring the difference in the actual prices paid in comparison with the standard prices set for the product. This deviation of actual price if found to be lesser than the standard price then it is considered as favorable, if found greater then it is unfavorable.
The formula used to determine the Direct Materials Price Variance is as below:
| Direct Materials Price Variance = Actual Quantity Used x (Actual Price – Standard Price) |
For example, ABC Company produces a product which requires a unit raw material for a unit production of the final product. If the standard cost of unit raw material is set at $ 1.00 per unit and during the month of September, 20xx; the company used 5000 units of raw material purchased at $ 0.8 to produce 2500 units of final product.
The direct materials price variance = 5000 x (0.8 – 1)
= -1000
Thus having actual price lesser than the standard price, this variance is favorable to the company.
If the same material if purchased only 500 units and is purchased at $ 1.5, then the variance becomes unfavorable with direct materials price variance
= 500 x (1.5-1)
= 250
The price of material here has varied due to the order size where the supplier has given discount on ordering 5000 units while sold at a higher cost when purchased only 500 units. Thus the price variance is favorable at 5000 units at 0.8$ than 500 units at 1.5$.
The variance may be observed due to size of the order based on which the suppliers allow discounts as compared to their regular price; increase in demand which allows suppliers to increase actual price resulting in favorable variance; increase in price due to inflation or general price level which may result in unfavorable variance; due to quality of materials which will accordingly rise the price of materials which may lead to deviation from the standard price; and additional cost of transportation which raise the price of products.
On other hand, the Direct Materials Efficiency Variance or the Direct Materials Quantity Variance is the deviation in the actual quantity used as compared to the standard quantity to be used for the production. This could be due to lower operation efficiency or consumption of higher materials due to wastage or so on and thus is termed as materials efficiency variance. Thus, if the Materials quantity variance is positive implies unfavorable and vice versa.
The formula used to compute the Direct Material’s Quantity Variance is as below:
| Materials Quantity Variance = Actual Price x (Actual quantity used – Standard quantity) |
Consider the same example as above where in ABC Company is said to consume 1 unit of raw material for unit production of finished good. This is the standard requirement considered.
As given, during the month of September 20xx, 5000 units of raw material has been consumed for production of 2500 units of finished goods at $ 0.8. The materials price variance is observed to be favorable but the materials quantity variance is as computed below:
Given the standard requirement of 1 unit for unit production of finished goods, the standard requirement of raw materials for 2500 units of finished goods is 2500 units of raw materials. But, the actual materials consumed are 5000 units as against 2500 units indicating that it is unfavorable.
The Direct Material Efficiency Variance = $ 1 x (5000 -2500) units
= 2500
This variance thus is considered as unfavorable.
So, though the price variance is favorable for the company, the efficiency is poor utilizing higher units as compared to standard set indicating unfavorable efficiency. The price variance is more critical to maintain the profitability for the company but the efficiency as well matters as it equally affects the cost of product overall. (AFM, NA) (AFM, NA)
As discussed above, Wilson River also has observed a similar case of favorable price variance but unfavorable quantity/ efficiency variance inferring that the company’s efficiency is poor and need to focus on to improve profit margins by a higher extent and to perform effectively.
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Available at: http://www.accountingformanagement.org/direct-materials-price-variance/
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Available at: http://www.accountingformanagement.org/direct-materials-quantity-variance/
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Available at: https://www.academia.edu/11583632/Chapter_16_Cost_Allocation_Joint_Products_and_Byproducts
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Hussey, R., 2010. Fundamentals of International Financial Accounting and Reporting. s.l.:World Scientific.
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Available at: http://www.csuchico.edu/~wl10/320C06.ppt
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