Ch.

12

Below is an expanded, detailed summary of Chapter 12, including real examples to enhance
understanding of the concepts discussed in the text:

Enhancing Product Offerings at WestJet

 Case Study:
o WestJet, originally a low-cost airline, introduced premium options and regional
services to stay competitive against rivals like Air Canada Rouge.
o Relevant Costs Considered:
 Revenue from added premium services.
 Costs of upgrading cabin features and offering additional benefits like
priority boarding.
o Outcome: Increased load factor (79.2%) and record passenger numbers,
showcasing the importance of aligning product offerings with strategic goals.

Introduction to Relevant Costs

 Definition:
o Relevant costs are those that differ among alternatives and will be incurred in the
future.
o Examples:
 If deciding to drive or take a train, the cost of the train ticket is relevant,
while sunk costs like car depreciation are not.
 Irrelevant Costs:
o Include sunk costs (already incurred, e.g., car depreciation) and fixed costs that
remain unchanged across alternatives.

Decision-Making Examples

1. Driving vs. Taking the Train (Cynthia’s Weekend Trip)

 Cynthia wants to visit a friend in Moncton and evaluates the cost of driving versus taking
the train.
 Relevant Costs for Driving:
o Gas ($0.12/km), maintenance ($0.05/km), and parking in Moncton ($25/day for
two days).
o Total cost: $146.46.
 Relevant Costs for Taking the Train:
 o Round-trip ticket: $85.
 Qualitative Factors:
o Relaxation and study time on the train vs. having a car in Moncton.
 Decision: From a financial perspective, the train is $61.46 cheaper, but Cynthia must
weigh the qualitative benefits.

2. Labour-Saving Machine at OfficeMate

 OfficeMate considers renting a machine that costs $3,000 annually but reduces labour
costs by $15,000.
 Comparison of Current vs. New Situation:
o Operating income increases by $12,000 with the machine.
 Decision: Opt for the new machine as it improves profitability.

Adding or Dropping Product Lines

Example: AFM Electronics’ Digital Cameras

 The digital camera line shows an operating loss of $6,400. Management evaluates
whether to drop it.
 Key Data:
o Contribution margin lost if dropped: $16,000.
o Fixed costs avoided if dropped: $12,000.
 Outcome:
o Dropping the line would decrease overall income by $4,000.
o Decision: Retain the product line unless a more profitable use of resources
emerges.

Make-or-Buy Decisions

Example: OSN Cycles

 OSN Cycles produces gear shifters but receives an offer from an outside supplier to
purchase them for $19 each.
 Internal Production Costs:
o Avoidable costs (e.g., materials, labour): $14 per unit.
 Opportunity Cost:
o If production space could be used for a new product generating $60,000 annually,
the decision changes.
 Decision:
 o Without opportunity costs, continue producing internally as it’s $5/unit cheaper.
o With opportunity costs, buying externally may be preferable.

Special Orders

Example: OSN Cycles Police Bikes

 The company receives a request to produce 100 custom bikes at $560 each, below the
normal price of $700.
 Analysis:
o Incremental revenue: $560/unit.
o Incremental costs (materials, labour, modifications): $508/unit.
o Fixed costs for design: $1,200.
o Outcome: Additional income of $4,000.
o Decision: Accept the order as it increases operating income.

Sell or Process Further

Example: St. Thomas Wool Cooperative

 The cooperative separates raw wool into undyed coarse, fine, and superfine grades, with
options to sell as-is or dye them.
 Analysis:
o Incremental revenue vs. incremental costs of dyeing.
o Coarse wool: Process further incurs a $10,000 loss.
o Fine and superfine wool: Processing adds $30,000 and $20,000 in profits,
respectively.
o Decision:
 Sell coarse wool as-is.
 Process fine and superfine wool further.

Utilization of Constrained Resources

Example: OSN Cycles’ Panniers

 The company makes mountain and touring panniers but faces a bottleneck in stitching
machine time.
 Contribution Margin per Unit:
o Mountain pannier: $10.
o Touring pannier: $8.
  Contribution Margin per Minute:
o Mountain: $2.50.
o Touring: $4.00.
 Decision: Prioritize touring panniers as they provide higher profitability per minute of
constrained time.

Key Takeaways

 Relevant cost analysis is essential for:

o Adding or dropping product lines.
o Make-or-buy decisions.
o Accepting special orders.
o Selling or processing further.
o Maximizing constrained resources.
 Practical Tip: Focus on costs and revenues that differ between alternatives and align
decisions with strategic goals.

Ch.10

Key Concepts

1. Standard Costs:
o Benchmarks or norms for measuring performance.
o Include quantity standards (amount of input needed) and cost standards (price
of input).
o Used for planning, budgeting, and controlling operational costs.
2. Variance Analysis:
o Variances compare actual costs to standard costs to identify discrepancies.
o Price Variance: Difference between actual price and standard price.
o Quantity Variance: Difference between actual usage and standard usage.
3. Overhead Costs:
o Composed of fixed and variable costs.
o Require analysis of budget variances (budgeted vs. actual) and volume variances
(impact of production levels).
4. Management by Exception:
o Focuses on investigating significant variances to identify and resolve underlying
issues.

Examples

1. Catalyst Paper Corporation:

o Uses a model to estimate transportation costs for each shipment.
 o Compares actual shipping costs to the model's standards to identify variances
caused by factors like mode changes (rail vs. truck) or unexpected carrier charges.
2. Heirloom Pewter Company:
o Produces pewter bookends and tracks variances in material usage and labour
efficiency.
o Identifies:
 Favourable price variance: Negotiating lower raw material costs.
 Unfavourable quantity variance: Inefficient material use due to low-
quality purchases or inexperienced workers.
3. Labour Variance:
o Example: Heirloom Pewter had an unfavourable labour efficiency variance
because new hires required additional time to complete tasks.
4. Variable Overhead Example:
o A company incurs overhead based on machine hours or labour hours.
o Efficiency variance reflects the impact of using more hours than standard.
5. Fixed Overhead Example:
o Fixed overhead budget variance arises when actual fixed costs differ from the
flexible budget (e.g., depreciation costs).
o Volume variance occurs if production levels vary from the expected level used in
budget planning.

Takeaways

 Feedback Mechanism: Variance analysis provides critical feedback for controlling costs
and improving efficiency.
 Practical Standards: Tight but attainable standards encourage operational efficiency and
accurate forecasting.
 Integrated Decision-Making: Collaboration between departments (e.g., purchasing and
production) is key to resolving variances.

Summary of Chapter 10: Standard Costs and Overhead Analysis

Chapter 10 delves into standard costing systems and overhead variance analysis. It emphasizes
the importance of using standard costs for budgeting, cost control, and performance evaluation,
while also discussing potential pitfalls.

Key Concepts

1. Budget Variance

 Measures the difference between actual fixed overhead costs incurred and the budgeted
(flexible budget) fixed overhead costs.
  Formula:
Budget Variance = Actual Fixed Overhead − Flexible Budget Fixed Overhead
 Example:
At Heirloom Pewter Company:
Actual fixed overhead = $27,500
Flexible budget fixed overhead = $25,000
Budget variance = $2,500 U (Unfavourable)

2. Volume Variance

 Reflects the utilization of plant facilities by comparing the standard hours allowed for
actual output to the planned denominator activity level.
 Formula:
Volume Variance = Fixed Overhead Rate × (Denominator Hours − Standard Hours
Allowed)
 Example:
At Heirloom Pewter:
Predetermined fixed overhead rate = $6 per DLH
Denominator hours = 4,167
Standard hours allowed = 5,000
Volume variance = $6 × (4,167 − 5,000) = $5,000 F (Favourable)
This indicates higher facility utilization than planned.

3. Overhead Variances

 Categories:
o Variable Overhead Spending Variance: Difference between actual costs and
the budgeted cost for the actual hours worked.
o Variable Overhead Efficiency Variance: Difference due to actual hours used
versus standard hours for the output.
o Fixed Overhead Budget Variance: Difference between actual and budgeted
fixed overhead.
o Fixed Overhead Volume Variance: Arises when standard hours differ from
denominator hours.
 Heirloom Pewter Example:
o Total variable overhead cost: $390 U
o Fixed overhead cost: $2,500 U
o Total overhead variance: $2,110 F (favourable).

4. Cautions in Fixed Overhead Analysis

  Fixed costs are expressed on a per-hour basis for costing but do not vary with activity
levels. Misinterpreting them as variable can lead to errors in decision-making.
 Example:
Supervisory salaries for June exceeded the budget by $2,000, which requires
investigation, as it caused a significant fixed overhead budget variance.

Performance Reporting

Performance reports provide detailed insights into variances:

1. Spending Variance: Reflects cost control.

2. Efficiency Variance: Reflects resource utilization.
3. Example of Report:
Variable Overhead for 5,400 DLH:
o Indirect labor: Budget = $8,100, Actual = $7,830 → $270 F
o Lubricants: Budget = $5,400, Actual = $5,022 → $378 F
o Total spending variance = $810 F

For Fixed Overhead, only spending variances are analyzed:

 Supervisory salaries: Budget = $12,000, Actual = $14,000 → $2,000 U

 Total fixed overhead variance = $2,500 U

Capacity Analysis

Analyzing productive capacity helps evaluate lost opportunity costs:

1. Levels of Capacity:
o Theoretical Capacity: Maximum production with no downtime.
o Practical Capacity: Adjusted for unavoidable downtime.
2. Example:
Heirloom Pewter produces 16,000 units but could theoretically produce 40,000 units.
Opportunity cost = Lost profits from not utilizing full capacity = $792,000.

International Use of Standard Costs

Standard costing remains globally relevant:

 Over 70% of companies in the UK and Japan use it.

 Common in industries for cost control, budgeting, and product costing.
Advantages of Standard Costs

1. Facilitates management by exception by highlighting deviations.

2. Provides benchmarks for performance evaluation.
3. Simplifies bookkeeping by using predetermined rates.
4. Integrates with responsibility accounting for accountability.

Potential Problems

1. Delayed Reporting: Monthly variance reports may become outdated.

2. Blame Culture: Excessive focus on variances can harm morale and decision-making.
3. Misinterpretation of Labour Costs: Assumes labour is variable, but often it is fixed.
4. Overemphasis on Standards: May ignore quality or customer satisfaction.
5. Continuous Improvement Needed: Just meeting standards might not be enough in
competitive markets.

Real-World Applications

 In manufacturing, variances guide cost control and process efficiency.

 In healthcare, the application of standard costs is debated due to challenges in defining
precise patient treatment standards.

Conclusion

Standard costing systems are vital tools for performance evaluation, cost control, and decision-
making. While beneficial, they require careful application and interpretation to avoid unintended
consequences, ensuring they serve both financial and operational goals effectively.

Deeper Insights and Applications of Key Concepts

Here’s an in-depth look at specific calculations and practical applications to help understand and
apply the concepts from the chapter.

1. Budget Variance

The Budget Variance identifies whether actual fixed costs are higher or lower than expected.
Formula:

Budget Variance=Actual Fixed Overhead−Flexible Budget Fixed Overhead\text{Budget

Variance} = \text{Actual Fixed Overhead} - \text{Flexible Budget Fixed
Overhead}Budget Variance=Actual Fixed Overhead−Flexible Budget Fixed Overhead

Application:

 Scenario: Heirloom Pewter's actual fixed overhead costs are $27,500, but the budgeted
amount was $25,000.
 Calculation: Budget Variance=27,500−25,000=2,500 U\text{Budget Variance} = 27,500
- 25,000 = 2,500 \, UBudget Variance=27,500−25,000=2,500U
 Interpretation: An unfavorable variance means more was spent than budgeted.
Management could investigate areas such as supervisory salaries, depreciation, or
insurance to determine the cause.

2. Volume Variance

The Volume Variance shows whether production levels utilized the plant capacity effectively.

Formula:

Volume Variance=Fixed Overhead Rate×(Denominator Hours−Standard Hours Allowed)\

text{Volume Variance} = \text{Fixed Overhead Rate} \times (\text{Denominator Hours} - \
text{Standard Hours
Allowed})Volume Variance=Fixed Overhead Rate×(Denominator Hours−Standard Hours Allow
ed)

Application:

 Scenario: Heirloom Pewter's fixed overhead rate is $6 per DLH. Denominator hours are
4,167, and standard hours allowed are 5,000.
 Calculation: Volume Variance=6×(4,167−5,000)=6×(−833)=−4,998 F\text{Volume
Variance} = 6 \times (4,167 - 5,000) = 6 \times (-833) = -4,998 \,
FVolume Variance=6×(4,167−5,000)=6×(−833)=−4,998F
 Interpretation: A favorable volume variance occurs when more hours (5,000) were used
compared to the planned denominator level (4,167), indicating better-than-expected
utilization of plant facilities.

3. Overhead Variance Breakdown

A comprehensive variance breakdown helps identify controllable and uncontrollable factors.

Example (Heirloom Pewter):

Variance Type Amount F/U Key Insight

Controlled costs like indirect labor were well-
Variable Overhead Spending $810 F
managed.
Variable Overhead
$1,200 U Excess labor hours suggest inefficiencies.
Efficiency
Fixed Overhead Budget $2,500 U Overspending on fixed costs needs investigation.
Higher-than-planned utilization reduced per-unit
Fixed Overhead Volume $5,000 F
costs.

4. Performance Reports

Performance reports compare actual, flexible budget, and standard budget costs.

Example Report:

Heirloom Pewter’s June overhead cost breakdown:

Actual Budget for Actual Budget for Standard Spending Efficiency

Cost Type
Costs DLH (5,400) DLH (5,000) Variance Variance
Indirect
$7,830 $8,100 $7,500 $270 F $600 U
Labor
Lubricants $5,022 $5,400 $5,000 $378 F $400 U
Power $2,538 $2,700 $2,500 $162 F $200 U

5. Capacity Analysis

Capacity analysis evaluates the opportunity cost of underutilized production capacity.

Example (Heirloom Pewter):

Level of Units Contribution Margin Total Overhead Operating

Capacity Produced per Unit Costs Income
Theoretical 40,000 $105 − $64.50 = $40.50 $600,000 $1,020,000
Practical 25,000 $40.50 $487,500 $525,000
Denominator 20,000 $40.50 $450,000 $360,000
Actual 16,000 $40.50 $420,000 $228,000

Opportunity Cost of Lost Capacity:

Lost Income=Theoretical Operating Income−Actual Operating Income\text{Lost Income} = \

text{Theoretical Operating Income} - \text{Actual Operating
Income}Lost Income=Theoretical Operating Income−Actual Operating Income
Lost Income=1,020,000−228,000=792,000\text{Lost Income} = 1,020,000 - 228,000 =
792,000Lost Income=1,020,000−228,000=792,000

This highlights the need to improve production processes or increase demand.

6. Decision-Making with Variances

Managers should investigate:

1. Large variances: Supervisory salaries had a $2,000 U variance, indicating potential

overspending.
2. Patterns: Continuous unfavorable variances for lubricants suggest inefficiency in
procurement or storage.
3. Root causes: Examine higher utility bills or excess labor hours contributing to variances.

7. Insights on International Use

 Japan: Over 80% of companies use standard costing, integrating it into production and
budget controls.
 Healthcare: In U.S. hospitals, adopting standard costs for procedures (e.g., cardiac
surgery) faces challenges due to patient variability and ethical concerns.

Conclusion

Understanding and applying these concepts through detailed variance analysis, performance
reporting, and capacity evaluation empowers managers to:

 Pinpoint inefficiencies.
 Control costs effectively.
 Enhance decision-making by using data-driven insights.

Ch. 9

Comprehensive Summary of Budgeting Concepts with Real-Life Examples

Budgeting is a financial planning tool that helps individuals and organizations allocate resources
effectively to achieve goals. It involves estimating income and expenses, setting priorities, and
monitoring progress over time. Below are key budgeting concepts, summarized with real-life
examples for clarity:

1. Types of Budgets

 Personal Budget:
o Example: Sarah earns $4,000 monthly. She allocates 50% to needs (e.g., rent,
utilities), 30% to wants (e.g., dining out, entertainment), and 20% to savings using
the 50/30/20 Rule.
 Organizational Budget:
o Example: A nonprofit allocates $100,000 annually—$70,000 for program
delivery, $20,000 for operational costs, and $10,000 for fundraising efforts.

2. Fixed vs. Variable Expenses

 Fixed Expenses:
o Regular, unchanging costs like rent or insurance.
o Example: John pays $1,200 in rent each month, a fixed expense he plans for in his
budget.
 Variable Expenses:
o Costs that fluctuate, such as groceries or electricity.
o Example: John’s grocery bill varies from $200 to $300 monthly, depending on
family needs.

3. Common Budgeting Methods

 Zero-Based Budgeting:
o Every dollar is allocated a purpose, with no leftover funds.
o Example: Emma earns $3,000 monthly and allocates $1,500 to rent, $500 to
groceries, $400 to savings, and $600 to discretionary spending. She assigns every
dollar to a category.
 Incremental Budgeting:
o Adjusting the previous period's budget by a set percentage.
o Example: A company increases its marketing budget by 5% over the last year’s
$50,000 to accommodate inflation, making it $52,500.
 Activity-Based Budgeting:
o Based on specific activities and their costs.
o Example: A startup calculates the cost of hosting a customer event by accounting
for venue rental ($2,000), catering ($1,500), and promotional materials ($500).
4. Income and Expense Tracking

 Monitoring Cash Flow:

o Example: Michael uses a budgeting app to track his income of $5,000 and
expenses of $4,700 monthly, ensuring a positive cash flow.
 Identifying Overspending:
o Example: Maria notices her monthly dining-out expenses exceed her $200 budget,
prompting her to reduce frequency.

5. Budget Variance

 Analyzing Differences:
o Favorable Variance: When actual spending is less than budgeted.
 Example: A family budgets $300 for utilities but spends $250 due to
energy-saving efforts.
o Unfavorable Variance: When actual spending exceeds the budget.
 Example: A department budgets $10,000 for equipment but spends
$12,000 due to unexpected repairs.

6. Emergency Funds

 Importance:
o Setting aside funds for unforeseen events.
o Example: Jessica saves six months’ worth of expenses ($12,000) for emergencies
like job loss or medical bills.

7. Capital vs. Operating Budgets

 Capital Budget:
o Long-term investments in assets.
o Example: A school allocates $200,000 for new classroom construction and
equipment.
 Operating Budget:
o Day-to-day expenses.
o Example: A cafe budgets $5,000 monthly for supplies, wages, and utilities.
8. Savings and Investments

 Savings Goals:
o Example: David saves $500 monthly to reach his goal of a $6,000 vacation fund
in one year.
 Retirement Planning:
o Example: Lisa contributes 10% of her income to her 401(k) retirement plan,
benefitting from employer matching.

9. Tools for Budgeting

 Manual Tools:
o Using spreadsheets for detailed tracking.
o Example: Daniel uses Excel to create a budget template for his household
expenses.
 Digital Apps:
o Tools like Mint or YNAB (You Need a Budget).
o Example: Rebecca uses Mint to get real-time updates on her spending and savings
progress.

10. Challenges and Solutions

 Challenge: Sticking to a Budget:

o Example: John often overspends on entertainment.
o Solution: He sets alerts on his budgeting app to prevent overspending.
 Challenge: Unexpected Expenses:
o Example: A sudden car repair costs $800, disrupting Anna’s monthly budget.
o Solution: Anna’s emergency fund covers the cost without derailing her savings
plan.

11. Benefits of Budgeting

 Financial Clarity:
o Example: A freelancer tracks irregular income to plan for slow months.
 Debt Management:
o Example: Paul allocates 20% of his income to repay a $10,000 credit card debt
within five years.
 Goal Achievement:
o Example: A couple budgets monthly to save for a down payment on their first
home.
By integrating these principles into your daily life or business, you can maintain control over
finances, anticipate challenges, and achieve financial goals. If you'd like help tailoring a budget
or analyzing a specific scenario, let me know!