CMA Part 1: Financial Reporting,

Planning, Performance and Control

Section C: Cost Management

Study Note # 1: How are flexible budget variances on a sales
variance report calculated?
Answer: Flexible Budget Variances on a Sales Variance Report
can be calculated in the same way as manufacturing input Price
Variances (the Direct Materials Price Variance and the Labor Rate
Variance) are calculated:

(AP – SP) × AQ

In the formula above, the “AP” stands for the actual average
revenue or cost per item sold, the “SP” stands for the budgeted
average revenue or cost per item sold, and the “AQ” stands for the
actual number of units sold.

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Section C: Cost Management

Study Note # 2: How are sales variances used?
Answer: Sales variances are used to explain the differences
between actual and budgeted amounts of revenue, variable costs,
and the contribution margin. Revenues, variable costs, and the
contribution are the line items that are most affected by the
changes in the amount of each product that is sold, the price each
unit is sold for, and the cost of each unit sold.
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Section C: Cost Management

Study Note # 3: How are sales volume variances on a sales
variance report calculated?
Answer: The Sales Volume Variances on a Sales Variance
Report represent the variances caused by the number of units sold
having been different from the number of units budgeted to be
sold. The Sales Volume Variance can be calculated using the
same formula that is used for manufacturing input Quantity
Variances, where the “AQ” stands for the actual quantity sold,
“SQ” stands for the static budget quantity budgeted to be sold, and
“SP” stands for the budgeted average price per unit (for revenue)
or average variable cost per unit (for variable costs):

(AQ – SQ) × SP

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 4: How is the direct labor efficiency
variance calculated?
Answer: The direct labor efficiency variance is calculated the
same manner as the direct materials quantity variance:

(Actual Hours − Standard Hours for Actual Output) × Standard

Rate

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 5: How is the direct labor rate
variance calculated?
Answer: The direct labor rate variance is calculated in the same
manner as the direct materials price variance:

(Actual Rate – Standard Rate) × Actual Hours

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Section C: Cost Management

Study Note # 6: How is the sales mix variance for a multiple-
product firm calculated?
Answer: The Sales Mix Variance measures the effect of the
difference between the proportions of total units sold represented
by each product as planned compared to what actually occurred.

Just as we did with the manufacturing mix variance, we will use

waspAM (the weighted average standard price for the actual mix)
and waspSM (the weighted average standard price for the
standard mix) in calculating the Sales Mix Variance for the
revenue line:

(waspAM – waspSM) × AQ

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 7: How is the sales quantity variance for
a multiple-product firm calculated?
Answer: The Sales Quantity Variance measures the effect of the
difference between the actual total units sold of all products and
the budgeted total units of all products expected to be sold. The
Sales Quantity Variance does not take into consideration
variances due to differences in the mix of products sold.

To calculate the Sales Quantity Variance for a multiple-product

firm, we use the Quantity Variance formula, but we use the
weighted average standard price for the standard mix (waspSM)
in the formula in place of the standard price:

(AQ – SQ) × waspSM

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Section C: Cost Management

Study Note # 8: How is the sales volume variance for a multiple-
product firm calculated?
Answer: The total Sales Volume Variance for a multiple-product
firm is calculated by using the Sales Volume Variance for each
product individually and then summing the individual variances:

∑ (AQ – SQ) × SP

Sales Volume Variance can in turn be broken down into two sub-
variances: the Sales Quantity Variance and the Sales Mix
Variance.

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 9: How is the selling price variance for a multiple-
product firm calculated?
Answer: The Selling Price Variance (the Flexible Budget Variance
for revenue) for a multiple-product firm is determined by
calculating each product’s individual selling price variance and
summing them:

∑ (AP – SP) × AQ

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Section C: Cost Management

Study Note # 10: How should transactions between
subsidiaries of multinational corporations be priced?
Answer: Transactions between subsidiaries of multinational
corporations are supposed to be priced as “arm’s-length”
transactions. In other words, the prices should be the same as
they would be if the two parties were not related and should not
be adjusted simply to shift income between countries to reduce
the overall tax payment.
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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 11: Input cost variances are subdivided into
what two causes?
Answer: A price variance that reflects the difference between
actual and budgeted input prices.
A quantity variance, also called an efficiency variance, that
reflects the difference between actual and budgeted
input quantities used.

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 12: What are avoidable costs and unavoidable
costs and how are they relevant in the decision-making process?
Answer: An avoidable cost is a cost that can be avoided if a
particular option is selected. It is a cost that would go away if sales
to a particular customer stopped or if the company stopped
manufacturing a product. Avoidable costs are relevant costs to the
decision-making process because they will continue if one course
of action is taken but they will not continue if another course of
action is taken.
An unavoidable cost is an expenditure that will not be avoided
(i.e., will not go away) regardless of which course of action is
taken. Unavoidable costs would be costs for idle production
facilities that would not be used if the product were discontinued
but that the company could not dispose of.
Only costs that would be avoided (i.e., costs that would go away)
if the product or customer is dropped are relevant to the decision
of whether or not to drop the product or customer.

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Section C: Cost Management

Study Note # 13: What are common costs?
Answer: Common costs are costs of operating a business that
cannot be allocated to any specific user or users on any cause-
and-effect basis. Examples of common costs are the chief
executive officer’s salary, the costs of the financial reporting
function of the accounting department, and the costs of the budget
department.
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Section C: Cost Management

Study Note # 14: What are cost drivers?
Answer: Cost drivers are costs that are the result of activities that
are undertaken to create products or render services.
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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 15: What are key performance indicators?
Answer: Key performance indicators are the few critical metrics
that are most relevant to a company's specific business strategy,
and a company should track these measures rigorously rather
than using many different measurements. Key performance
indicators are measures of the aspects of the company’s
performance that are essential to its competitive advantage and
therefore its success.
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Section C: Cost Management

Study Note # 16: What are lagging indicators and leading
indicators?
Answer: Financial measures that focus on short-term financial
performance are in fact lagging indicators of how the company is
doing.

Nonfinancial measures focus on performance that should

ultimately result in improved long-term financial performance.
Thus nonfinancial measures are leading indicators of
performance.

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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 17: What are Level 1 variances?
Answer: Level 1 variances are the most global variances. Static
budget variances are Level 1 variances. They are based on the
income statement and merely compare the actual results with the
static (master) budget. Since they are based on the income
statement, Level 1 variances report variances in revenue and cost
of sales for sold units only. They do not report detailed cost
variances for all units produced.
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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 18: What are Level 2 variances?
Answer: Each of the static budget variances can be further broken
down into two sub-variances: the flexible budget variance and the
sales volume variance. These are Level 2 variances, because they
give us more information about the static budget variances. These
variances are also in income statement format. Because they are
based on the income statement and thus report on revenues and
costs for items sold, these variances are also called sales
variances. The term “sales variances” distinguishes them from
manufacturing input variances, which are based on items
produced.
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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 19: What are Level 3 variances?
Answer: Level 3 variances can give us more information about
the causes of the variances. Level 3 variances include
manufacturing input variances, sales variances, sales quantity
variances, and sales mix variances.
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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 20: What are levels in variance analysis?
Answer: Variances can be classified in terms of level. A level
denotes the amount of detail that is provided by the variance. A
low-level variance provides the least detail, whereas more
information is provided by a variance with a higher-level number.
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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 21: What are manufacturing input variances?
Answer: Manufacturing input variances are a special class of
variances. They include direct materials, direct labor, and
manufacturing overhead used in production. These variances are
concerned with inputs to the manufacturing process, as follows:
Whether the amount of inputs used per unit manufactured was
over or under the standard (a quantity, or efficiency, variance),
Whether the inputs used cost more or less per unit than the
standard (a price variance), and
What the monetary impact was of each type of variance.

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Section C: Cost Management

Study Note # 22: What are relevant revenues and relevant
costs and why are they important in the decision-making
process?
Answer: Relevant revenues and relevant costs are those
expected future revenues and costs that differ among alternatives.
Only relevant revenues and costs need to be considered in the
decision-making process because:
It is important to focus on the future since nothing can be done to
change past costs that have already been incurred (called sunk
costs). Because decisions focus on selecting future courses of
action, sunk costs are irrelevant to the decision process.
We must focus only on the factors that differ among alternatives.
Revenues and costs that are the same between options are not
relevant because they will be the same no matter which option is
selected.

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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 23: What are shared services?
Answer: Shared services are used by internal departments and
usage of the service by the individual departments or products can
be allocated to user departments in a meaningful way based upon
a cost driver that represents their usage of the service.
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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 24: What are the advantages of residual
income?
Answer: The primary advantage of RI is that a project beneficial
to the company is more likely to be selected, even if its ROI is
lower than the unit’s existing ROI. (Using RI as a performance
measure instead of ROI overcomes the tendency of managers to
reject projects that would be profitable to the company but that
would lower the business unit’s current ROI.)
Another advantage of RI is that a firm can adjust its required rates
of return for differences in risk. A unit with higher business risk can
be evaluated using a higher required rate of return than that which
is used for a unit with lower business risk.
RI also enables a company to use a different investment charge
for different classes of assets. For example, the company could
use a higher required rate of return for long-lived assets, especially
if their resale value is expected to be low, and a lower required
rate of return for shorter-term assets (such as inventory).

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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 25: What are the common methods of setting a
transfer price?
Answer: Market price: Market price is a transfer price equal to the current or market
price of the selling division’s product in an “arm’s-length” transaction.

Cost of production plus opportunity cost: The cost of production plus opportunity cost
includes the cost of production (outlay cost) and the profit margin that the selling division is
giving up by selling the product internally rather than externally.

Variable cost: The variable cost method uses only the selling division’s variable costs as
the transfer price.

Full cost: The full cost method includes all materials, labor, and a full allocation of overhead
in determining a transfer price. The full cost of production is calculated using absorption
costing.

Cost plus: Under the cost plus method of setting transfer prices, the selling division adds
either a fixed dollar amount or a percentage of costs to the cost of production to
approximate a normal profit markup.

Negotiated price.

Arbitrary pricing.

Dual-rate pricing: Under the cost plus method of setting transfer prices, the selling division
adds either a fixed dollar amount or a percentage of costs to the cost of production to
approximate a normal profit markup.

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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 26: What are the disadvantages of using ROI for
performance measurement?
Answer: The main problem with ROI as a performance
measurement that it measures return as a percentage rather than
as a dollar amount. If the expected ROI of a new project under
consideration is lower than the division’s present ROI but higher
than the target rate, the manager may reject a profitable project
because it would lower the division’s overall ROI, even though the
project would be beneficial for the company. While it is good to
have a higher rate of return, the company is ultimately interested
in the amount of the return.

Another disadvantage of using ROI for performance

measurement is that when a manager is evaluated using current
ROI, the pressure to meet the current period’s ROI target may
cause short-term profits to take precedence over long-term
profits.

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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 27: What are the five areas where all divisions
should use the same accounting policies?
Answer: Inventory cost flow assumptions.
Depreciation method.
Asset capitalization policy.
Use of full costing.
Disposition of manufacturing variances.
Any differences among divisions in the way that revenues,
expenses, and assets are accounted for can significantly influence
interpretation of the divisions’ ROIs and their comparability.

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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 28: What are the four Balanced Scorecard
perspectives?
Answer: The Financial perspective focuses on the organization’s financial
objectives and enables tracking of financial success and shareholder value.

The Customer perspective involves identifying the market segment or

segments the company wants to target and then measuring its success in
those segments. A common method of measuring this success is the trend in
the company’s share of the market over time and the degree to which it
increases in line with management goals. Customer satisfaction is another
vital part of the customer perspective, because if customers are not satisfied
they will take their business elsewhere.

The Internal Process perspective includes innovations and improvements in

products and services, operations, and customer service/support needed to
create value for customers, which in turn furthers the Financial perspective.

The Learning and Growth perspective (originally called the innovation and
learning perspective) formerly focused on employee learning, but it now
covers not only human capital but also organizational capital and information
capital. Initially innovation was part of this perspective, but users of the
balanced scorecard system discovered that innovation properly belonged in
the Internal Process category.

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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 29: What are the four levels used for evaluation on
the contribution income statement?
Answer: Level 1: Manufacturing Contribution Margin (Net Revenue Less Variable
Manufacturing Costs). The manufacturing contribution margin of the company is the
amount of money that is available to cover nonmanufacturing variable costs, all fixed costs,
and then flow to profit.

Level 2: Contribution Margin (Manufacturing Contribution Less Variable Nonmanufacturing

Costs). The contribution margin of the company is the amount of money that is available to
cover fixed costs and then flow to profit after all variable costs are covered.

Level 3: Controllable Margin (Contribution Margin Less Controllable Fixed Costs). The
controllable margin (also called short-term segment manager performance) is important
because it is a measurement of all the revenues and expenses (variable and fixed) that are
controllable by the individual managers on a short-term (that is, less than one year) basis.
The controllable margin is a useful measure of a manager’s short-term performance.

Level 4: Segment Margin (Controllable Margin Less Non-controllable, Traceable Fixed

Costs). The segment margin (also called contribution by strategic business unit, or
contribution by SBU) is a measure of the performance of each business unit. It may also
be used as a measure of the long-term performance of the manager, if the manager can
control the non-controllable traceable fixed costs over a long-term period. However, in
many cases, decisions that affect non-controllable traceable fixed costs are made by
others.

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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 30: What are the limitations of Level 1 variances?
Answer: Variances caused by more or fewer sales than planned
are not segregated from variances caused by other factors.
Comparison of actual with the master budget focuses on short-
term performance instead of long-term success.
Managers should be evaluated on performance measures other
than just whether or not they have met short-term financial targets.
Meeting financial targets is only part of the measurement of
performance. Manager evaluation should include not only financial
measures but also non-financial measures.

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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 31: What are the main classifications of
responsibility centers?
Answer: The main classifications of centers, listed in order of the
most fundamental (or basic) to the most complex, are:
A Cost Center is responsible only for the incurrence of costs. A
cost center does not earn any revenue and therefore generates
no profit.
A Revenue Center is the opposite of a cost center in that it is
responsible only for revenues.
A Profit Center is a department responsible for both revenues and
expenses.
An Investment Center is responsible for profit (revenues and
costs) and for providing a return on the capital that has been
invested into it by the larger organization to which it belongs.
Because it is responsible for a return-on-investment, this type of
department is the most like a regular and complete business by
itself. However, it is still part of a larger organization.

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 32: What are the main purposes for responsibility
centers and responsibility accounting?
Answer: The main purposes for responsibility centers and
responsibility accounting are the evaluation of subunits’
performance and to contribute to measuring the performance of
the subunits’ managers. Manager performance measurement
provides motivation for managers of the subunits, which in turn
benefits the company as a whole. The manager of a responsibility
center should have the ability to control, or at least significantly
influence, the results of the center over which he or she has
control.
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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 33: What are the mix variance and yield variance?
Answer: The mix variance shows the portion of the quantity
variance that resulted because the actual mix was different from
the standard mix (that is, more of one ingredient was used and
less of another ingredient was used). The yield variance shows
the portion of the quantity variance that resulted because
the total actual amount of all ingredients used was different from
the total standard amount.
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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 34: What are the most common factors when
deciding which transfer pricing method to use?
Answer: The goals of the company and what method will best
enable those goals to be met (goal congruence), and
Factors relating to the capacity of the producing division, its ability
to sell the product on the open market, and the ability of the
purchasing division to buy the product on an open market.

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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 35: What are the objectives of a transfer pricing
system?
Answer: It should promote goal congruence.
It should motivate the profit center managers to pursue their own profit
goals while also working toward the success of the entire company. The
selling division should be motivated to hold its costs down, and the buying
division should be motivated to acquire and use the inputs efficiently.
It should help senior managers evaluate the performance of individual
sub-units.
t should preserve autonomy in decision making among managers of
divisions, if senior management wants a decentralized organization.
It should be equitable, permitting each unit of a company to earn a fair
profit for the functions it performs.
It should meet legal and external reporting requirements.
It should be easy to apply.

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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 36: What are the problems with the balanced
scorecard?
Answer: It is difficult to use scorecards for comparisons across business units because
each business unit has its individualized scorecard. Scorecard evaluation is more effective
when it is used to judge the progress of an individual business unit relative to the prior year
or relative to its goals rather than when used to compare a manager’s performance with
that of other managers or a segment’s performance with that of other segments.

In order to implement balanced scorecard performance measurement, a firm must have

extensive enterprise resource planning systems to capture the required information.

Non-financial data is not subject to control or audit and thus its reliability could be
questionable.

The efficacy of the balanced scorecard in achieving the organization’s strategic goals must
be monitored closely. If all of the non-financial targets are achieved but the financial targets
are not achieved, then probably a strong causal relationship does not exist between the
non-financial indicators chosen for monitoring and the financial goals. The non-financial
indicators may need to be re-evaluated and changed.

If the balanced scorecard is used as a “command and control” document that is used to
control behavior, employees may “make the numbers” but not be committed to achieving
the organization’s goals. Instead, the balanced scorecard should be used to create an
environment in which everyone can learn and grow.

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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 37: What are the two ways to allocate common
costs?
Answer: The stand-alone cost allocation method determines the
weights for cost allocation by considering each user of the cost as
a separate entity. When the stand-alone method is used, total common
costs are distributed among the operating units based on each unit’s
proportion of the entire organization, using an appropriate basis.
Advocates of the stand-alone method maintain that it is fairer than the
incremental cost-allocation method because each responsibility center
bears a proportionate share of total costs.
The incremental cost-allocation method ranks units according to their
size or on some similar basis. The largest unit is called the primary party.
The primary party is charged for costs up to what its cost would be if it
were the only unit. The remaining cost is allocated to the other unit or
units, called incremental parties. The effect of the incremental method is
that the largest unit bears all the fixed common costs plus an allocation
of the variable common costs, whereas the incremental parties bear only
an allocation of the variable common costs.

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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 38: What are the weaknesses of residual
income?
Answer: First, it focuses on the dollar amount of the return. Although a $1
return might be beneficial for a company, the amount of the return may be
so small in comparison to the amount invested that the return is not worth
the effort.

Another disadvantage of RI is that it is difficult to compare the performance

of subunits of different sizes. A large subunit would probably have a larger
Residual Income than a small unit, but the smaller unit might have a higher
rate of return on its employed assets despite it lower RI.
In addition, a small change in the required rate of return would have a
greater absolute effect on the amount of a large unit’s RI than it would on
the RI of a small unit.
Furthermore, RI has the same issues as ROI with respect to distortion
caused by the accounting policies selected by the company. Residual
Income must be interpreted carefully because of the various effects of
different accounting policies on operating income and on the amount of
investment.

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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 39: What is a contribution income statement?
Answer: On a contribution income statement, fixed costs are
segregated from variable costs and presented on separate lines.
Only variable costs are allocated to production and thus to the
units sold. Variable expenses include not only variable production
costs but also variable selling, general, and administrative
expenses. The contribution margin is the difference between
revenues and all variable expenses (both production and non-
production variable expenses). All fixed expenses, both
production and non-production, are reported below the
contribution margin line as a reduction to the contribution margin.
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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 40: What is a process costing system?
Answer: A process costing system is used to assign costs to
individual products when the products are all relatively similar and
are mass-produced, as on an assembly line.
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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 41: What is a responsibility center?
Answer: A responsibility center is any part, segment, or subunit
of an organization. A segment may be a product line, a
geographical area, or any other meaningful unit. Companies will
have different segments based on their activities.
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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 42: What is a strategy map?
Answer: A strategy map links the four balanced scorecard
perspectives together. When the company’s financial and non-
financial measures are linked in this way, the non-financial
measures serve as leading indicators of the firm’s future financial
performance. The strategy map provides a way for all employees
to see how their work is linked to the corporation’s goals.
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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 43: What is a transfer price?
Answer: A transfer price is the price charged by one sub-unit of a
company to another sub-unit of the same company for the services
or goods produced by the first sub-unit and “sold” to the second
sub-unit. The product or service that is sold and purchased
internally is called an intermediate product. It may be used as a
component of a product that is sold to the final customer by the
center that purchased it internally, or the center that purchased it
may sell it outright to the final customer.
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 CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section C: Cost Management

Study Note # 44: What is balanced scorecard?
Answer: The balanced scorecard is a widely-used strategic
performance management tool designed to manage strategic
performance. The balanced scorecard transforms an
organization’s strategic plan from a passive document into the
"marching orders" for the organization in its day-to-day activities.
It provides a framework that not only provides performance
measurements but helps management to identify what needs to
be done and how its achievement can be measured. The balanced
scorecard enables execution of strategies.
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Section C: Cost Management

Study Note # 45: What is customer profitability analysis?
Answer: Customer profitability analysis determines the
profitability of an individual customer or a group of customers,
enabling managers to coordinate their customers’ costs-to-serve.
A manager might want to re-price activities that cause high costs-
to-serve or reduce available services for customers that are high
cost-to-serve. To customers that are identified as low cost-to-
serve, the manager can offer discounts in order to increase the
sales volume from that group of customers. The most profitable
customers can be provided with improved customer service in
order to maintain their loyalty.
If a particular customer is unprofitable because of the particular
products or services the customer is purchasing or using, the
manager may be able to shift that customer’s mix toward higher-
margin products and services, thereby converting an unprofitable
customer into a profitable customer.

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Section C: Cost Management

Study Note # 46: What is job-order costing?
Answer: Job-order costing is a method in which all of the costs
associated with a specific job (or client) are accumulated and
charged to that job (or client).
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Section C: Cost Management

Study Note # 47: What is meant by favorable and unfavorable
variance?
Answer: A favorable variance (represented with the letter F) is a
variance that causes actual net operating income to be higher than
the budgeted amount. An unfavorable variance (represented with
the letter U) is a variance that causes actual net operating income
to be lower than the budgeted amount.
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Section C: Cost Management

Study Note # 48: What is residual income (RI)?
Answer: Residual Income (RI) attempts to overcome the
weakness in ROI by measuring the dollar amount of return that is
provided to the company by a department or division. RI for a
division is calculated as the amount of return (operating income
before taxes) that is in excess of a targeted amount of return on
the investments employed by that division. Residual income is the
operating income earned after the division has covered the
required charge for the funds that have been invested by the
company in its operations.

Two items that you need to know in regard to the calculation of RI

are:
The targeted amount of return is usually some percentage of, or
rate of return on, the total employed assets of the division, or
the invested capital in the division, and
The percentage used in the calculation is the required rate of
return that management has set.
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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 49: What is responsibility accounting?
Answer: Responsibility accounting is an accounting system that
measures accounting results of each responsibility center
separately. It is also used to measure the consolidated results of
the company as a whole.
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Section C: Cost Management

Study Note # 50: What is return on investment (ROI)?
Answer: Return on Investment (ROI) can be used to evaluate the
performance of the entire firm, but it can also be used to evaluate
the performance of single divisions and their division managers.

ROI is the key performance measure for an investment center. It

measures the percentage of return that was provided on the dollar
amount of the investment (that is, assets). The calculation is:

Income of the Business Unit ÷ Assets (Investment) of the Business

Unit

If ROI is used as an evaluation tool, management must be certain

that it is the correct measurement for the company’s goals and that
the ROI goals are representative of that individual department’s
market and business.

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Section C: Cost Management

Study Note # 51: What is the fixed overhead production-volume
variance?
Answer: The fixed overhead production-volume variance is the
difference between the budgeted amount of fixed overhead and the
amount of fixed overhead applied (standard rate × standard input for the
actual level of output). The Fixed Overhead Production-Volume Variance
is caused by a difference between the actual production level and the
production level used to calculate the budgeted fixed overhead rate.
The fixed overhead production-volume variance has no connection to
any actually incurred costs, so it is not a comparison between actual and
budgeted costs in the way other variances are. Instead, it is a measure
of capacity utilization.
The fixed overhead production-volume variance is calculated as:
Budgeted Fixed Overheads (the flexible budget OR the static budget
amount)
– Standard fixed overhead applied (standard rate × standard input for
actual output)
= Fixed Overhead Production-Volume Variance

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Section C: Cost Management

Study Note # 52: What is the fixed overhead spending variance?
Answer: The fixed overhead spending variance, also called the
flexible budget or the budget variance, is the difference between
the actual fixed overhead costs incurred and the budgeted fixed
overhead (flexible budget and/or static budget) amount.

Actual Fixed Overhead Incurred

– Budgeted Fixed Overheads (the flexible budget OR the static
budget amount)
= Fixed Overhead Spending/Flexible Budget Variance

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Section C: Cost Management

Study Note # 53: What is the flexible budget variance?
Answer: The flexible budget variance on a sales variance report
is the difference between the actual results and the flexible budget.
Actual Results – Flexible Budget Amount = Flexible Budget
Variance
The flexible budget is budgeted amounts that have been adjusted
to the actual level of sales activity that has occurred. The flexible
budget variance tells us how much of the static budget variance
was caused by factors other than the difference between actual
and budgeted sales volume

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 54: What is the formula for residual income?
Answer: The formula for residual income is:

Operating income before taxes for the division, project, or

investment opportunity
– Target return in dollars: Employed assets of the business unit ×
required rate of return
= Residual Income

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Section C: Cost Management

Study Note # 55: What is
the materials price (or labor rate) variance of a weighted mix?
Answer: The price variance of a weighted mix is the sum of the
price variances for each component of the mix, each one
calculated individually using the formula (AP – SP) × AQ.

We will calculate a price variance for each separate input, and

these individual price variances are then summed to calculate the
total materials price variance.

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 56: What is the materials purchase price variance?
Answer: A materials price variance computed at the time of
purchase is called a materials purchase price variance. Note that
this variance is called the “materials purchase price variance,”
which is different from the materials price usage variance we
calculated above. The materials purchase price variance is
calculated in exactly the same way as the materials price usage
variance, except the AQ (Actual Quantity) used in the formula is
the quantity of direct materials purchased, not the quantity of direct
materials used.
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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 57: What is
the materials quantity (or labor efficiency) variance of a
weighted mix?
Answer: The total materials quantity or labor efficiency variance
of a weighted mix is the sum of the quantity variances for each
component of the mix, each one calculated individually.

The formula (AQ – SQ) × SP is used to calculate the quantity

variance for each component of the mix separately. The individual
quantity variances are then summed to calculate the total quantity
variance.

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 58: What is the mix variance (materials or
labor)?
Answer: The mix variance is the portion of the quantity variance
that results from the actual mix of materials used or the actual mix
of the labor used being different from the standard mix that should
have been used. The formula used to calculate the mix variance
is a variation of the price variance formula: (AP – SP) × AQ.
Instead of using the actual and standard prices for the input, we
use weighted average standard prices.

[Weighted Average Standard Price of the Actual Mix − Weighted

Average Standard Price of the Standard Mix
(both calculated using the Standard Price)] x Actual Quantity of all
material or labor inputs

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 59: What is the price variance?
Answer: The price variance measures how much of the total
variance was caused by having paid a different amount for the
material than had been budgeted.

The price variance is calculated as:

(Actual Price − Standard Price) × Actual Quantity

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 60: What is the primary benefit of Level 1
variances?
Answer: The primary benefit of measuring performance by
comparing actual results with the master budget is that it provides
a means for management to recognize the unexpected variances,
thus pointing out which operating variances need to be
investigated. Recognition of variances that need to be investigated
is one of the most important steps in the budgeting process.
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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 61: What is the profit margin ratio?
Answer: A profit margin ratio is a measure of the amount of sales
that actually become profits. It is the net income (or profit) amount
divided by revenue (or sales). In order to increase the profit margin
a manager must either:
Increase sales while holding costs constant, or
Decrease costs without losing sales, or
Increase sales at a rate greater than the increase in costs.

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 62: What is the quantity variance?
Answer: The quantity variance (also called
the efficiency or usage variance) measures how much of the
variance is due to using more or less direct material than
budgeted.

The quantity variance is calculated as:

(Actual Quantity − Standard Quantity for Actual Output) ×
Standard Price

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Section C: Cost Management

Study Note # 63: What is the sales volume variance?
Answer: The sales volume variance on a sales variance report is
the difference between the flexible budget amount and the static
budget amount.
Flexible Budget Amount – Static Budget Amount = Sales Volume
Variance
The sales volume variance shows how much of the static budget
variance was caused by actual sales volume being different from
budgeted sales volume.

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 64: What is the total direct material variance?
Answer: The total direct material variance is also the flexible
budget variance for direct material. The total direct material
variance is easy to calculate. It is the difference between the actual
direct materials costs for the period and the standard costs for the
standard amount of materials at the standard price per unit for the
level of output actually produced (the flexible budget).
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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 65: What is the total fixed overhead variance?
Answer: The total fixed overhead variance is the difference
between the actual fixed overhead incurred and the amount that
was applied using the standard rate and the standard usage of the
application base for the actual level of output.

Actual fixed overhead incurred (money actually spent)

– Standard fixed overhead applied (standard rate × standard
usage for actual output)
= Total fixed overhead variance

The total fixed overhead variance can be broken down into two
other variances: the spending (or budget) variance and
the production-volume variance.

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 66: What is the total labor variance?
Answer: The total labor variance (also called the flexible budget
variance) is the difference between the standard labor costs
allowed for the actual level of output (the flexible budget) and the
actual labor costs incurred by the company. The total variance is
attributable to variances in both labor rates and labor usage,
meaning that the company either paid a different wage rate than
standard, used a different number of labor hours than standard for
this level of output, or did both.
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Section C: Cost Management

Study Note # 67: What is the total overhead flexible budget
variance?
Answer: The total overhead flexible budget variance measures the difference
between actual overhead incurred and the flexible budget overhead. The Total
Overhead Flexible Budget Variance includes these three of the four overhead
sub-variances:

Variable Overhead Spending Variance.

Variable Overhead Efficiency Variance.

Fixed Overhead Spending Variance.

The Total Overhead Flexible Budget Variance does not include the Fixed
Overhead Production-Volume Variance because the Fixed Overhead
Production-Volume Variance is not a comparison between actual and budgeted
costs as the other variances are.

The total overhead flexible budget variance is:

Actual total variable and fixed overhead incurred (money spent on these items)

– Total flexible budget variable and fixed overhead amounts for the actual output

= Total Overhead Flexible Budget Variance

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 68: What is the total overhead variance?
Answer: The total overhead variance includes both the variable
and the fixed overhead variances:
Actual total variable and fixed overhead incurred (money actually
spent on these items)
– Total variable and fixed overhead applied to production using
predetermined rates
= Total Overhead Variance
The total overhead variance is the same as the amount of over- or
under-applied factory overhead. Over- and under-applied
overhead is calculated as Actual Overhead Incurred minus
Applied Overhead. The formula above is the same formula as the
formula for over- and under-applied overhead.

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 69: What is the total variable overhead variance?
Answer: The total variable overhead variance is equal to the
difference between the actual variable overhead incurred and the
standard variable overhead applied. The standard variable
overhead applied is based on the standard usage (given the actual
output) of the overhead allocation base (machine hours, direct
labor hours, and so forth).

Actual total variable overhead incurred (money spent on these

items)
– Variable overhead applied to production using predetermined
rate
= Total variable overhead variance

The total variable overhead variance may be broken down into

the spending and efficiency variances.

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 70: What is the total variance of a weighted mix?
Answer: The total variance of a weighted mix is the Total Actual
Cost for labor or materials minus the Total Standard Cost for labor
or materials.
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Section C: Cost Management

Study Note # 71: What is the variable overhead efficiency
variance?
Answer: The variable overhead efficiency variance is essentially a
quantity variance, and it determines the amount of the total variance
caused by a different usage of the allocation base than was expected
(that is, the standard hours allowed for the actual output). It measures
the effect on variable factory overhead cost of efficient or inefficient use
of the allocation base used to apply the variable overhead.
Budgeted variable overhead based on inputs actually used (AQ x SP)
− Standard variable overhead allowed for production/applied to
production (SQ x SP)
= Variable overhead efficiency variance
The variable overhead efficiency variance is also calculated as:
(Actual Quantity of VOH Allocation Base Used for Actual Output –
Standard Quantity of VOH Allocation Base Allowed for Actual Output) ×
Standard Application Rate

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 72: What is the variable overhead spending
variance?
Answer: This variance is the difference between the actual amount of variable
overhead incurred and the standard amount of variable overhead allowed for the
actual quantity of the VOH allocation base used for the actual quantity produced.

The variable overhead spending variance is essentially a price variance and this
variance is caused by a difference between the actual variable overhead cost per
unit of the allocation base (calculated as the actual overhead costs ÷ the actual
usage of the allocation base) and the standard application rate per unit of the
application base.

Actual total variable overhead incurred (money actually spent)

– Budgeted variable overhead based on inputs actually used

= Variable overhead spending variance

The variable overhead spending variance can also be calculated as:

(Actual VOH Cost Per Unit of Allocation Base Actually Used – Standard VOH Cost
Per Unit of Allocation Base [i.e., Standard Application Rate]) × Actual Quantity of
VOH Allocation Base Used for Actual Output

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 73: What is the yield variance (materials or
labor)?
Answer: The yield variance results from a difference between
the total actual quantity of the inputs that were used to produce
the actual output and the total standard quantity of inputs that
should have been used to produce the actual output.

The formula to calculate the yield variance is a variation of

the quantity variance of the mix: (AQ – SQ) × SP. Instead of using
the standard price of a single input, we use the weighted average
standard price of the standard mix.

[Actual Total Quantity of All Inputs – Standard Total Quantity of All

Inputs] × Weighted Average Standard Price of Standard Mix of All
Inputs

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 74: What is three-way analysis of overhead?
Answer: In three-way analysis, the three variances are the
volume, efficiency, and spending variances.
The volume variance is equal to the production-volume variance
as calculated for fixed overhead.
The efficiency variance is equal to the variable overhead
efficiency variance.
The spending variance is equal to the variable overhead spending
variance plus the fixed over-head spending variance.

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 75: What is two-way analysis of overhead?
Answer: Two-way analysis uses the same information as
calculated for four-way analysis, but we are going to combine it in
a slightly different manner than we do under three-way analysis.
The two variances involved are called the volume variance and
the controllable (or budget) variance.
The volume variance is equal to the production-volume variance
for fixed overhead.
The controllable variance is equal to the sum of the remaining
three variances, which are the variable spending variance,
variable efficiency variance, and fixed spending variance.

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 76: What is variance analysis?
Answer: Variance analysis is the process of comparing the actual
expenses and revenues during a certain period to the budgeted
amounts for that same period. With variance analysis we are able
to determine the reasons why our actual results were different
from the budgeted amounts. Knowing the reasons will enable us
to focus our efforts on the areas that have been operating less
efficiently than planned.
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Section C: Cost Management

Study Note # 77: What other transactions affect
the measurement of operating income and ROI?
Answer: Nonrecurring items: Nonrecurring charges or revenues
can prevent operating income of a given business unit from being
comparable to that of prior periods and from being comparable to
operating income of other business units.
Income taxes: Income taxes may affect various units differently,
especially if the units are located in different countries with
different tax rates and varying tax treaties. Even within one
country, there may be different local or regional taxes.
Foreign exchange: Operating income and value of investments in
foreign countries can vary due to fluctuations in currency
exchange rates.
Joint asset sharing: Costs for common facilities or services need
to be allocated on a fair basis, as discussed in Allocation of
Common Costs. Different methods of allocating the common costs
will result in different costs for each unit and thus will affect the
units’ operating income.

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 78: What sources can be used to set appropriate
standards for usage and prices?
Answer: Activity analysis involves identifying, delineating or
outlining, and evaluating all the activities necessary to complete a
job, a project, or an operation.
Historical data.
Benchmarking uses current practices of similar operations in other
firms.
Target costing sets costs based on the price that the product can
be sold for.
Strategic decisions.

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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 79: When the budget amount is subtracted from
the actual amount, a negative variance for a cost or
expense item is a [Favorable or Unfavorable] variance?
Answer: Favorable
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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 80: When the budget amount is subtracted from
the actual amount, a negative variance for an income item is a
[Favorable or Unfavorable] variance?
Answer: Unfavorable
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Section C: Cost Management

Study Note # 81: When the budget amount is subtracted from
the actual amount, a positive variance for a cost or
expense item is a [Favorable or Unfavorable] variance?
Answer: Unfavorable
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 CMA Part 1: Financial Reporting,
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Section C: Cost Management

Study Note # 82: When the budget amount is subtracted from
the actual amount, a positive variance for an income item is a
[Favorable or Unfavorable] variance?
Answer: Favorable
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