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1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review Planning, Control and Analysis Chapter Eight ©Black CPA Review www.BlackCPAreview.com Chapter 8 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review Objectives: Objective 1: Understand cost-­‐volume-­‐profit (CVP) analysis Objective 2: Know the difference between variable and absorption costing Objective 3: Understand corporate budgeting Objective 4: Understand the various methods for forecasting sales Objective 5: Understand standard costing and variance analysis Objective 6: Know the elements of project management ©Black CPA Review www.BlackCPAreview.com Chapter 8 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review Objective 1: Understand cost-­‐volume-­‐profit (CVP) analysis A. Cost-­‐volume-­‐profit analysis is a tool used by management to determine the effects of a change in price, sales volume, variable expense, fixed expense, and profits. CVP allows management to determine the breakeven point, as the CVP provides a profitability estimate within a relevant range. a. Breakeven analysis allows management to determine either a number of units or a dollar amount that the company must sell in order for the gains to equal the expenses. Any amount over the breakeven point is profit. i. Breakeven formula: (Sales Price x X) = (variable costs x X) + fixed costs 1. X is the number of units needed to breakeven. 2. Example: A company produces a product that sells for $4. The variable costs are $0.75 per unit and fixed costs are $12,000 $4X = $0.75X x $12,000 $3.25X = $12,000 X = 3,692 units The company must sell 3,692 units at $4 to breakeven. ii. There are shortcuts to finding the breakeven point by using the contribution margin (CM). 1. This is the amount of sales less variable costs. In the prior example the contribution margin per unit was $3.25 ($4 -­‐ $0.75). 2. Short cut formula: Units to break even = Fixed costs ÷ CM per unit X = $12,000 ÷ $3.25 X = 3,692 units iii. The contribution margin can also be used to determine the dollar amount of sales needed to break even. 1. Formula = dollars needed to breakeven = Fixed costs ÷ CM percentage X = $12,000 ÷ ($3.25 ÷ $4) X = $12,000 ÷ 81.25% X = $14,769 b. Breakeven analysis for multiple products – when determining the breakeven point for a company that sells multiple products, you must determine the composite number of units using the company’s sales mix. i. Example: A company sells the following products with a sales mix of 5 units of A for every 3 units of B (5:3) and fixed costs of $25,000 Products A B Selling Price $3 $1.50 Variable costs Contribution margin $0.80 $2.20 $0.75 $0.75 ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 1 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review ii. Step one: Determine the composite contribution margin Composite CM = 5($2.20) + 3($0.75) Composite CM = $13.25 iii. Step two: Determine the number of composite units to breakeven Composite units needed to be sold = Fixed costs ÷ composite contribution margin Composite units = $25,000 ÷ $13.25 Composite units = 1,887 iv. Step three: Determine the units of Product A and B that need to be sold Product units = Composite units X sales mix A: 1,887 X 5 = 9,434 units of A that must be sold to breakeven And: B: 1,887 X 3 = 5,660 units of B that must be sold to breakeven The company must sell 9,434 units of A and 5,660 units of B to breakeven. Objective 2: Know the difference between variable and absorption costing A. They only difference between the two costing systems is that variable costing treats fixed manufacturing overhead as a period cost rather than a product cost. This means that variable costing expenses fixed manufacturing overhead in the period the costs were incurred, whereas absorption costing treats the fixed manufacturing overhead as a product cost, expensing the overhead when the products are sold. a. Variable costing is not acceptable for GAAP reporting so it is only used for internal reporting. b. Absorption costing is the preferred method for external reporting under GAAP. B. The different ways of costing the fixed manufacturing overhead will cause variable and absorption costing to have different net incomes. a. The relationship between variable and absorption costing: Scenario Outcome Sales = Production (a.k.a. no change in inventory) Income is the same for both Variable income < Absorption income Sales < Production (a.k.a. increase in inventory) Sales > Production (a.k.a. decrease in inventory) Variable income > Absorption income ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 2 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review Objective 3: Understand corporate budgeting A. Budgeting is an important tool used by management. It helps management to develop an effective strategic plan to accomplish a company’s goals. B. Master budget – A summary of all of the individual budgets within the company. This is a static budget that summarizes the following budgets: a. Financial budget – A group of budgets that includes the capital budget, the cash budget, a budget balance sheet, and statement of cash flows b. Operating budget – A group of budgets consisting of a budgeted income statement and supporting schedules C. There are three types of budgets with which to be familiar. a. Static budget – A budget developed for a specific level of activity b. Kaizen budget – A budget developed based on a continuous process of improvement c. Flexible budget – A budget that can fluctuate based on the level of activity because the variable costs are separate from the fixed costs. D. A company must prepare the budgets in the following order: a. Sales budget – A forecast of the company’s anticipated sales b. Production budget – A budget used to determine how many goods a company needs to produce. i. Formula: Budgeted Sales + Desired ending inventory Total units needed -­‐ Beginning inventory Units needed to be produced ii. Example: A company needs to budget for 1,000 units to be sold. They want to have 200 units in ending inventory and they have 150 units in beginning inventory. According to the formula below, the company needs to produce an additional 1,050 units. Budgeted Sales + Desired ending inventory Total units needed -­‐ Beginning inventory Units need to be produced 1,000 200 1200 (150) 1,050 ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 3 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review c. Materials purchase budget – Used to budget for payments of raw materials i. Formula: + -­‐ = X = + -­‐ = + -­‐ = Units sold Budgeted increase in finished goods Budgeted decrease in finished goods Units to be manufactured Units of raw material per unit of finished goods Units of raw material required for production Budgeted increase in raw materials Budgeted decrease in raw materials Budgeted raw material purchases Budgeted decrease in accounts payable Budgeted increase in accounts payable Budgeted payments for raw materials d. Cash receipts and disbursements budget – Shows the budget’s inflows and outflows of cash. E. Approaches to budgeting a. Two types i. Top-­‐down (management) – Management determines the budget’s constraints based on their objectives and goals, and passes it down through the organization. 1. A disadvantage of this type of budgeting is that it may put unrealistic constraints on lower level managers and employees. This occurs because upper management may have unrealistic expectations concerning what the lower level management may be able to do. ii. Bottom-­‐up (participative) – Lower level employees have input in the initial budgeting process. 1. This may produce a more realistic budget, however the process is more time consuming. Objective 4: Understand the various methods for forecasting sales A. As discussed in a prior objective, the first budget that should be developed is the sales budget. There are several ways in which management is able to estimate or forecast future sales. a. Qualitative approaches – When there are no quantitative approaches to determining a company’s future sales, management may use qualitative approaches that are based on judgment rather than quantifiable measurements. Qualitative approaches include: i. Executive opinions – Management uses their experience and expert opinion to determine what they think the amount of sales will be. ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 4 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review ii. Customer surveys – Current customers are asked what their projected purchase volume will be. iii. Delphi technique – Experts are given a series of questionnaires to help management determine the projected future sales volume. b. Quantitative approaches – Allow management to calculate the forecasted sales. There are three types of quantitative approaches. i. Historical approach 1. Decomposition of time series – Prior sales are examined to determine if there is a cyclical or seasonal effect. 2. Exponential smoothing – An approach that averages prior sales in order to forecast future sales. This method gives more weight to recent sales. 3. Moving average – An approach that averages prior sales to forecast future sales. 4. Naïve models – Uses observations of prior sales and other variables in order to estimate future sales. ii. Observed associations approach 1. Econometric models – Combines regression analysis with economic models to forecast sales. 2. Regression analysis – Uses the relationship between prior sales and an additional variable in order to estimate future sales. iii. Consumer behavior approach 1. Markov technique – Determines the company’s market share, which allows them to forecast sales. Objective 5: Understand standard costing and variance analysis A. Standard costing – A corporation determines the target costs for materials, labor, and overhead that the company should be able to achieve if they are operating at maximum efficiency. Determining the target costs helps companies to budget their manufacturing costs a. Standards – used to budget for costs i. Standard price (SP) – The targeted purchase price per unit of input. This is the price per unit of direct materials. ii. Standard quantity (SQ) – The targeted number of units of direct materials needed to produce one product. iii. Standard rate (SR) – The targeted price paid for each hour of direct labor. iv. Standard hours (SH) – The targeted amount of hours of direct labor needed to complete one product. v. Applied overhead (a.k.a. budgeted overhead or standard fixed application rate) – Targeted amount of overhead to be applied to each product produced. ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 5 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review b. Actuals – used to determine the variances from budget costs to actual costs, which helps management to produce more accurate budgets in the future i. Actual quantity (AQ)– The actual amount of direct materials used to make one unit of output. ii. Actual price (AP) – The actual cost of one unit of direct material. iii. Actual rate (AR) – The actual hourly cost of labor. iv. Actual hours (AH) – The actual hours needed to complete one unit of a product. v. Actual overhead – The actual overhead applied to each product produced. c. Direct materials (DM) variances i. DM Price Variance = AQ(SP-­‐AP) 1. If the AP > SP, then there is an unfavorable price variance. This means that the company paid more for the materials than they budgeted. ii. DM Quantity Variance = SP(SQ – AQ) 1. If AQ > SQ, then there is an unfavorable quantity variance. This means that more materials were needed to produce one unit of output than was budgeted. d. Direct labor (DL) variances i. DL Rate Variance = AH(SR – AR) 1. If AR > SR, then there is an unfavorable variance. ii. DL Efficiency Variance = SR(SH – AH) 1. If AH > SH, there is an unfavorable variance. e. Overhead variances – The following 4 variances serve as the basis for all three variance methods discussed below. 1. Variable Overhead Spending Variance = Actual variable overhead -­‐ (AQ x SQ) 2. Variable Overhead Efficiency Variance = (AQ x SR) – (SQ x SR) 3. Fixed overhead spending variance = Actual Fixed overhead – budget amount 4. Fixed overhead volume variance = Budget amount – (SQ x SR) i. 4 variance method 1. (1) Variable Overhead Spending Variance = Actual variable overhead -­‐ (AQ x SQ) 2. (2) Variable Overhead Efficiency Variance = (AQ x SR) – (SQ x SR) ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 6 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review 3. (3) Fixed overhead spending variance = Actual Fixed overhead – budget amount 4. (4) Fixed overhead volume variance = Budget amount – (SQ x SR) ii. 3 variance method 1. (1+3) = Total Spending 2. (2) Variable overhead efficiency variance 3. (4) Fixed overhead volume variance iii. 2 variance method 1. (1 + 2 + 3) = Budget variance (a.k.a. controllable variance) 2. (4) Fixed overhead volume variance Objective 6: Know the elements of project management A. Project management involves managing a project with the following characteristics: a. Defined start and end dates b. Objectives c. Budget constraints d. Project involves multiple departments within a company e. Project expends the resources of a company including people and money. B. In order for a project manager to be effective, they must be able to handle the four elements of project management: a. Time – includes determining task timelines and requirements b. Money – includes developing project budgets, handling costs, and determining the profit c. Resources – The project manager determines how best to utilize company resources to complete the project d. Scope – The project manager determines the project size, requirements, and goals C. Effective project management requires a five phase process a. Phase one – Project initiation i. During this phase, the project is chosen by identifying the benefits and comparing them with the costs. ii. Once the project is chosen, management approves the project by issuing a project charter. 1. The charter gives the chosen project manager the authority to complete the project b. Phase two – Project planning i. This phase requires the project managers to determine: 1. What resources will be needed to complete the project 2. What the risks of the project are 3. What the scheduling of the activities and tasks will be. ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 7 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review ii. During the planning phase, the project manager will create a document known as the Statement of Work (SOW). This document includes a description of the project as well as: 1. Project specifications – Descriptions of the company’s resources, man-­‐hours, equipment and materials that will be used during the project. 2. Milestone schedule – a description of the major milestones of the project and the date they will be completed. 3. Work breakdown structure – If necessary, the project can be broken down into smaller sections to make resource budgeting easier. iii. Project managers often use a life-­‐cycle approach to planning projects. This involves breaking the project planning into different phases. Each phase must be evaluated and approved before the next phase can begin. iv. The following are techniques that may be used to help schedule and manage a project: 1. Gant chart – A bar graph that depicts the start and end times of the individual tasks needed to complete a project. 2. Network diagram – A way of visually representing which tasks must be completed before others can be started. 3. Milestone chart – Visually represents the milestones of a project. 4. Program Evaluation and Review Technique (PERT) – a technique used to determine the critical path of the project. a. The critical path is the order in which activities should be completed to finish the project in the shortest amount of time. b. The PERT technique uses three estimates of time i. Optimistic ii. Most likely iii. Pessimistic 5. Critical Path Method – like PERT, except that only one estimate of time is used. 6. Project crashing – A process of adding resources to a project’s activities in order to shorten the critical path time. Because of the ability that a manager has to shorten the project length by adding additional resources (i.e. trading money for time), there are two estimated project lengths: planned time and crash time. 7. ABC analysis – A process of ranking a project’s activities. a. A – Tasks that are the most urgent and important b. B – Tasks that are important but not urgent. c. C – Tasks that are not important or urgent c. Phase three – Project execution i. Project execution involves managing the tasks developed during the planning phase and handling any problems that may arise. ii. Problems may arise from the following: 1. Organizational uncertainty – Senior management has not properly set the chain of command for the project. ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 8 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review 2. Unusual decision pressures – Problems may occur because of needing to make a decision related to the project with incomplete information 3. Inadequate senior management support – Senior management may delay the progress of the project by not resolving conflicts, not providing resources, or not giving approval in a timely manner. d. Phase four – Project monitoring i. Project monitoring involves: 1. Tracking the project’s progress 2. Analyzing the outcome of the project 3. Comparing the outcome to the desired outcome 4. Making adjustments to the project e. Phase five – Project closure i. This involves determining that all the tasks have been completed, and receiving management sign-­‐off. ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 9 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review Questions Objective 1: Question 1: Jago Co. has two products that use the same manufacturing facilities and cannot be subcontracted. Each product has sufficient orders to utilize the entire manufacturing capacity. For short-­‐run profit maximization, Jago should manufacture the product with the: A. lower total manufacturing costs for the manufacturing capacity. B. lower total variable manufacturing costs for the manufacturing capacity. C. greater gross profit per hour of manufacturing capacity. D. greater contribution margin per hour of manufacturing capacity. Question 2: Based on potential sales of 500 units per year, a new product has estimated traceable costs of $990,000. What is the target price per unit to obtain a 15% profit margin on sales? A. $2,329 B. $2,277 C. $1,980 D. $1,935 Question 3: At the breakeven point, the contribution margin equals total: A. variable costs. B. sales revenues. C. selling and administrative costs. D. fixed costs. Question 4: At annual sales of $900,000, the Ebo product has the following unit sales price and costs: Sales price $20 -­‐-­‐-­‐-­‐ Prime cost 6 Manufacturing overhead Variable 1 Fixed 7 Selling and admin. costs Variable 1 Fixed 3 -­‐-­‐-­‐-­‐ 18 -­‐-­‐-­‐-­‐ Profit $ 2 == What is Ebo's breakeven point in units? A. 25,000 B. 31,500 C. 37,500 D. 45,000 ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 10 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review Objective 2: Question 5: At the end of a company's first year of operations, 2,000 units of inventory are on hand. Variable costs are $100 per unit and fixed manufacturing costs are $30 per unit. The use of absorption costing, rather than variable costing, would result in a higher net income of what amount? A. $60,000 B. $140,000 C. $200,000 D. $260,000 Question 6: A single-­‐product company prepares income statements using both absorption and variable costing methods. Manufacturing overhead cost applied per unit produced in the current year was the same as in the previous year. The variable costing statement reported a profit whereas the absorption costing statement reported a loss. The difference in reported income could be explained by units produced being: A. less than units sold. B. less than the activity level used for allocating overhead to the product. C. in excess of the activity level used for allocating overhead to the product. D. in excess of units sold. Question 7: Which of the following costing methods provides the added benefit of usefulness for external reporting purposes? I. Variable II. Absorption A. I only B. II only C. Both I and II D. Neither I nor II Objective 3: Question 8: Fargo Mfg., a small business, is developing a budget for next year. Which of the following steps should Fargo perform first? A. Forecast Fargo's sales volume B. Determine the price of Fargo's products C. Identify costs of Fargo's forecasted sales volume D. Compute the dollar amount of Fargo's forecasted sales Question 9: Card Bicycle Co. has prepared production and raw materials budgets for next year. At the end of this year, the finished product inventory is expected to include 2,000 bicycles and raw material inventory is expected to include 3,000 bicycle tires. Each finished bicycle requires two tires. The marketing department provided the following data from the sales budget for the first quarter: January February March -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ Expected Bicycle Sales (units) 12,000 16,000 18,000 ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 11 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review The company inventory policy is to have finished product inventory equal to 20% of the following month's sales requirements and raw material equal to 10% of the following month's production requirements. In the January budget for raw materials, how many tires are expected to be purchased? A. 24,200 B. 26,120 C. 26,600 D. 26,680 Question 10: Johnson Co. is preparing its master budget for the first quarter of next year. Budgeted sales and production for one of the company's products are as follows: Month Sales Production -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ -­‐-­‐-­‐-­‐-­‐-­‐-­‐ -­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐-­‐ January 10,000 12,000 February 12,000 11,000 March 15,000 16,000 Each unit of this product requires 4 pounds of raw materials. Johnson's policy is to have sufficient raw materials on hand at the end of each month for 40% of the following month's production requirements. The January 1 raw materials inventory is expected to conform with this policy. How many pounds of raw materials should Johnson budget to purchase for January? A. 11,600 B. 46,400 C. 48,000 D. 65,600 Question 11: Which of the following is a disadvantage of participative budgeting? A. It is more time consuming. B. It decreases motivation. C. It decreases acceptance. D. It is less accurate. Objective 4: Question 12: Cyclical fluctuations, random variations, seasonal variations, and secular trend are all components of: A. exponential smoothing. B. learning curve analysis. C. sales forecasting. D. time series analysis. Question 13: Older data is weighted less than newer or more recent data when using the statistical tool known as which of the following? A. Exponential smoothing B. Seasonal variation ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 12 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review C. Trend analysis D. None of the answer choices are correct. Question 14: The forecasting technique most relevant for analyzing data prior to creation of a flexible budget is: A. exponential smoothing. B. learning curves. C. regression analysis. D. time series analysis. Objective 5: Question 15: To meet its monthly budgeted production goals, Acme Mfg. Co. planned a need for 10,000 widgets at a price of $20 per widget. Acme's actual units were 11,200 at a price of $18.50 per widget. What amount reflected Acme's price variance? A. $7,200 unfavorable B. $15,000 favorable C. $16,800 favorable D. $24,000 unfavorable Question 16: The standard direct labor cost to produce one pound of output for a company is presented below. Related data regarding the planned and actual production activities for the current month for the company are also given below. (Note: DLH = Direct Labor Hours) Direct Labor Standard: .40 DLH at $12.00 per DLH = $4.80 Planned production 15,000 pounds Actual production 15,500 pounds Actual direct labor costs (6,250 DLH) $75,250 The company's direct labor rate variance for the current month would be: A. $10 unfavorable. B. $240 unfavorable. C. $248 unfavorable. D. $250 unfavorable. Question 17: The standard direct labor cost to produce one pound of output for a company is presented below. Related data regarding the planned and actual production activities for the current month for the company are also given below. (Note: DLH = Direct Labor Hours) Direct Labor Standard: .40 DLH at $12.00 per DLH = $4.80 Planned production 15,000 pounds Actual production 15,500 pounds Actual direct labor costs (6,250 DLH) $75,250 ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 13 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review The company's direct labor efficiency variance for the current month would be: A. $600 unfavorable. B. $602 unfavorable. C. $2,400 unfavorable. D. $3,000 unfavorable Question 18: The standard direct material cost to produce a unit of Lem is 4 meters of material at $2.50 per meter. During May of the current year, 4,200 meters of material costing $10,080 were purchased and used to produce 1,000 units of Lem. What was the material price variance for May? A. $400 favorable B. $420 favorable C. $80 unfavorable D. $480 unfavorable Objective 6: Question 19: Project management is the key to: A. planning, implementing, and monitoring. B. planning only. C. implementing and monitoring only. D. None of the answer choices are correct. Question 20: The implementation stage is the second step in project management. What does the implementation stage entail? A. Creating a schedule B. Creating the plan C. Holding meetings, monitoring progress, and tracking costs D. Releasing the final project Question 21: Which of the following is not considered a step in the planning stage? A. Create a communications plan B. Create a schedule C. Create a quality control plan D. Monitor the project ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 14 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review Answers Objective 1: Question 1: D In a full utilization situation, manufacturing capacity represents a scarce resource, or constraint. The question of importance is how to most profitably utilize this resource. Contribution margin (price minus variable cost) indicates profitability potential per unit of product. When this value is multiplied times the number of units that can be produced per hour, we can determine profit potential per hour for various products that might be produced. Thus, contribution margin per hour of manufacturing capacity is very relevant in a short-­‐run situation in which the entire manufacturing capacity is expected to be utilized. Question 2: B Selling price = Product cost + (Product cost x Markup %) = ($990,000 / 500) + (($990,000 / 500) x 0.15) = $1,980 + $297 = $2,277 Question 3: D The income statement equation is: Sales -­‐ Variable costs -­‐ Fixed costs = Net income or Sales -­‐ Variable costs = Fixed costs + Net income If net income is zero (i.e., at the breakeven point): Sales -­‐ Variable costs = Fixed costs Since Sales -­‐ Variable costs equals the contribution margin: Contribution margin = Fixed costs Question 4: C Prime cost consists of direct material and direct labor. Both of these are variable costs, so total variable cost is $8 per unit ($6 + $1 + $1). Current unit sales = $900,000 / $20 per unit = 45,000 units Total fixed costs = (45,000 x $7) + (45,000 x $3) = $315,000 + $135,000 = $450,000 Breakeven units = Total fixed costs / (Selling price -­‐ Variable cost) = $450,000 / ($20 -­‐ $8) = $450,000 / $12 = 37,500 units Objective 2: Question 5: A ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 15 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review Absorption costing assigns the fixed (overhead) costs as product costs. Variable costing considers the fixed costs as expense in the period incurred. The net income, therefore, would increase using absorption costing by the amount of overhead allocable to the units which are in inventory on hand at the end of the year. This is because those fixed costs are not considered an expense in absorption costing, but are considered one in variable costing. The fixed manufacturing costs allocable to the 2,000 units on hand at the end of the year would be $60,000 (2,000 × $30 per unit). Question 6: A Variable product costs (material, labor, and variable overhead) are charged against revenue in the period the product is sold under both absorption and variable costing. Fixed overhead is treated differently. It is expensed in its entirety during the period incurred under variable costing but under absorption costing it is applied to product and appears on the income statement only when the product is sold. In the situation described, absorption costing reported less income than variable costing because some of the previous year's fixed overhead was included in cost of goods sold as a result of producing less units than were sold in the current year. Fixed overhead is a product cost for absorption costing at time of sale and a period cost under variable costing at time of production. Question 7:B The difference between variable and absorption costing relates to the way fixed overhead costs are handled. Under variable costing, fixed manufacturing costs are period costs, and under absorption costing, fixed manufacturing costs are inventoriable. Since GAAP and tax law only allow the use of absorption costing, variable costing does not provide any benefits for external reporting purposes. Objective 3: Question 8: A The development of the budget begins with the forecasting of sales, since for most companies sales is a limiting factor—a combination of capacity and potential market share. The expected sales are often based on a combination of the sales from prior years and the company's percentage of the market adjusted for changes in economic conditions. The operating budgets are then prepared based upon the projected sales volume. Although sales volume can be affected by sales price, it is only one aspect of forecasting projected sales. In fact, the selling price may be dictated by production volume and/or market forces. Question 9: D January production = Jan. sales + Desired ending inventory -­‐ Beginning inventory = 12,000 + (0.20 x 16,000) -­‐ 2,000 = 13,200 bicycles February production = Feb. sales + Desired ending inventory -­‐ Beginning inventory = 16,000 + (0.20 x 18,000) -­‐ (0.20 x 16,000) = 16,400 bicycles January purchases = Production needs + Desired ending inventory -­‐ Beginning inventory ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 16 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review = (2 x 13,200) + (0.10 x 2 x 16,400) -­‐ 3,000 = 26,680 tires Question 10: B Johnson must budget for purchases to cover (1) 60% of the units produced in January (since 40% was left from December) and (2) 40% of units produced in February. Raw materials needed for January's production = 12,000 × 4 lbs. of materials per unit × 60% = • 28,800 pounds. Raw materials to cover 40% of February's needs = 11,000 × 4 lbs. of materials per unit × 40% = • 17,600 pounds. • Total materials to be purchased in January = 28,800 + 17,600 = 46,400 pounds. Question 11: A Participative budgeting is a bottom-­‐up budgeting process where budgets are developed after lower-­‐level managers have provided input in the development of the numbers. The thought is that lower-­‐level managers will feel an ownership of the budget if they have had a hand in developing the budget, and this ownership is hoped to lead to a greater motivation and goal congruence. Some of the disadvantages are the fact that the numbers provided by the lower-­‐level managers often contain budgetary slack, leading to negative motivation and the fact that it is more time consuming to involve additional people in the budgeting process Objective 4: Question 12: D Time series analysis focuses on evaluation of trends over time. It may entail several components including seasonal variation and secular trends. Question 13: A Exponential smoothing weights current data heavier than older data. It is used to smooth forecast variation. Exponential smoothing is a statistical method that is useful as a sales forecasting technique. This forecasting procedure is a special type of weighted moving average: it is reverse geometric progression in which the effect of past events (in this case sales) is discounted based on some multiple so that the effect which the past event has on current projections decreases as the time since the event increases. Question 14: C Flexible budgets are prepared (or can be prepared) for different levels of activity. In doing this, it is necessary to identify and separate variable costs and fixed costs. Regression analysis can be used to develop simple regression equations of the type y = a + b(x), where a represents the constant (i.e., fixed) cost and b represents the variable rate. This is what is needed for preparation of flexible budgets. Objective 5: Question 15: C Material price variance = Quantity purchased × (Standard price -­‐ Actual price) • Material price variance = 11,200 × ($20 -­‐ $18.50) • Material price variance = $16,800 This number is favorable because the actual price is lower than the standard price ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 17 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review Question 16: D $250 unfavorable derives from the actual direct labor hours (6,250) times the difference between the standard direct labor rate ($12.00) and the actual direct labor rate ($75,250 ÷ 6,250 = $12.04). Therefore, 6,250 × ($12.00 -­‐ $12.04) = $250. $10 unfavorable derives from the difference between the planned direct labor hours (15,000 • × .4 = 6,000) and the actual direct labor hours (6,250) times the difference between the standard direct labor rate ($12.00) and the actual direct labor rate ($75,250 ÷ 6,250 = $12.04) producing ((6,000 -­‐ 6,250) × ($12.00 -­‐ 12.04) = $10). $240 unfavorable derives from the planned direct labor hours (15,000 × .4 = 6,000) times the • difference between the standard direct labor rate ($12.00) and the actual direct labor rate ($75,250 ÷ 6,250 = $12.04) producing ((6,000) × ($12.00 -­‐ 12.04) = $240). $248 unfavorable derives from the direct labor hours allowed for actual production (15,500 × • .4 = 6,200) times the difference between the standard direct labor rate ($12.00) and the actual direct labor rate ($75,250 ÷ 6,250 = $12.04) resulting in ((6,200) × ($12.00 -­‐ 12.04) = $248). Question 17: A $600 unfavorable derives from the difference between the direct labor hours allowed for the output achieved (15,500 × .4 = 6,200) and the actual hours worked (6,250) times the standard direct labor rate ($12.00). Calculation: ((6,200 -­‐ 6,250) × $12). $602 unfavorable derives from the difference between the direct labor hours allowed for the • output achieved (15,500 × .4 = 6,200) and the actual hours worked (6,250) times the actual direct labor rate ($75,250 ÷ 6,250 = $12.04). Calculation: ((6,200 -­‐ 6,250) × $12.04). $2,400 unfavorable derives from the difference between the direct labor hours allowed for • the planned production (15,000 × .4 = 6,000) and the direct labor hours allowed for the output achieved (15,500 × .4 = 6,200) times the standard direct labor rate ($12.00). Calculation: ((6,000 -­‐ 6,200) × $12). $3,000 unfavorable derives from the difference between the direct labor hours allowed for • the planned production (15,000 × .4 = 6,000) and the actual hours worked (6,250) times the standard direct labor rate ($12.00). Calculation: ((6,000 -­‐ 6,250) × $12). Question 18: B For 1,000 units of LEM: $10,080 / 4,200 = $2.40 Material Quantity Difference between Price Variance = purchased and used x standard and actual cost = 4,200 meters x ($2.50 -­‐ $2.40) = 4,200 x $.10 = $ 420 Since actual price was less than standard price, this variance was favorable. The number of units produced (1,000) is a factor in calculating material quantity variance but not material price variance in this case. Objective 6: Question 19: A ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 18 1-­‐855-­‐75-­‐BLACK Business Environment and Concepts Review Project management is the key to planning, implementing, and monitoring. It does not stop with only planning, but encompasses all three processes of the project. Question 20: C The implementation stage includes holding meetings, monitoring the progress of the project, updating the project plan, tracking costs, and communicating the progress of the project. Remember that the implementation stage coincides with the planning stage. Question 21: D The planning stage is the planning of the project and does not go beyond planning. As a result, the planning stage of a project includes the following: • Creating the project plan • Creating a schedule • Creating a control plan • Creating a quality control plan • Creating a risk management plan • Creating a communications plan • Creating a completion plan Monitoring the project occurs at a later stage ©Black CPA Review www.BlackCPAreview.com Page 8 -­‐ 19