Unit 4: 1C.

Module 1
C.1. Cost and Variance
Measures: Part 1
Budgets
and Variances

2
C.1. Cost and Variance Measures: Part 1
Page 4-3 | LOS: 1C1a, 1C1b
Variances: Definition and Uses
• Variances stem from differences between reality (actuals) and expectations (budget)

• Used as both a control and a performance management tool

─ Cost center managers are evaluated based on differences between actual and planned costs.

─ Revenue center managers are evaluated based on differences between actual and budgeted revenue.

─ Profit center managers are evaluated based on differences between actual and budgeted profits.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 3
of Becker Professional Education Corporation or the copyright owner.
Variance Analysis
Using the Master
Budget

4
C.1. Cost and Variance Measures: Part 1
Page 4-4 | LOS: 1C1c
Performance Analysis: Actual to Budget
• The master (annual) budget uses a single level of activity.

• Variances compare the master budget with actual

• Favorable variances occur when:

─ Actual revenue exceeds budgeted revenue

─ Actual expenses are less than budgeted expenses

• Unfavorable variances occur when:

─ Actual revenue is less than budgeted revenue

─ Actual expenses are greater than budgeted expenses

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 5
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 1
Page 4-4 | LOS: 1C1d
Actual Performance vs. Master Budget: Benefits and Limitations
• Benefits

─ Relatively easy to calculate

─ Useful in identifying variances that require further investigation

• Limitations

─ Variances due to volume are not isolated

─ Variances due to inefficiencies are not isolated

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 6
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 1
Page 4-5 | LOS: 1C1e
Flexible Budgets
• Budgets presented for multiple sales volumes

• A more accurate reflection of expected sales, costs,

• Variances compare actual performance with budgeted

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 7
of Becker Professional Education Corporation or the copyright owner.
Sales
Variances

8
C.1. Cost and Variance Measures: Part 1
Page 4-6 | LOS: 1C1f
Sales Variance Analysis

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 9
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 1
Page 4-6 | LOS: 1C1f

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 10
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 1
Page 4-7 | LOS: 1C1f

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 11
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 1
Page 4-7 | LOS: 1C1n
Sales Mix Variance
• Accounts for sales of multiple products with different contribution margins

• Actual revenue and net income may differ from budgeted amounts even if sales volume meets projections

─ Caused by an actual sales mix difference from budgeted sales mix

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 12
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 1
Page 4-8 | LOS: 1C1n

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 13
of Becker Professional Education Corporation or the copyright owner.
Unit 4: 1C. Module 2
C.1. Cost and Variance
Measures: Part 2
Management by
Exception and
Standard Costing
C.1. Cost and Variance Measures: Part 2
Page 4-11 | LOS: 1C1i
Management by Exception
• Focus is on areas with the largest variances between actual results and budget standards

• Effort is devoted to problem areas requiring further analysis and potential correction

• Analysis of variances can lead to performance improvements

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 3
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-12 | LOS: 1C1j
Standard Costing System
• An accounting system aligned with flexible budgeting that captures standard costs per unit of output

• Standard costs are budgeted for all manufacturing costs (raw materials, direct labor, and manufacturing overhead)

• Standard input = Quantity of input allowed for a unit of output

• Standard price of a unit of input = Estimated price per unit of input used in the production of a unit of output

• Standard costing is useful for:

─ Cost control and process improvements

─ Performance evaluation (variance analysis)

─ Simplified bookkeeping

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 4
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-13 | LOS: 1C1h
Variance Calculations Using Standards
• Comparisons of actual costs to standards provide information on the efficiency and effectiveness of operations.

• Variances are typically calculated for:

─ Direct materials (DM)

─ Direct labor (DL)

─ Fixed manufacturing overhead (FOH)

─ Variable manufacturing overhead (VOH)

• Favorable (F) variances result in higher operating income and unfavorable (U) variances result in lower operating income.

• Controllable variances are preventable and within management control, while uncontrollable variances are not preventable.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 5
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-12 | LOS: 1C1j
Standard Cost Calculations

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 6
of Becker Professional Education Corporation or the copyright owner.
Direct Materials
and Direct
Labor Variance
C.1. Cost and Variance Measures: Part 2
Page 4-14 | LOS: 1C1k, 1C1l
Direct Materials Variances

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 8
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-15 | LOS: 1C1s

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 9
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-14 | LOS: 1C1k, 1C1l
Direct Labor Variances

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 10
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-16 | LOS: 1C1s

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 11
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-17 | LOS: 1C1o
Materials Mix Variance
• Usage of multiple types of materials requires dividing the materials quantity variance into mix and yield variances.

• Changing relative percentages for materials creates variances.

• Materials quantity mix variances result from changing the actual mix of materials used relative to the planned standard mix
of materials.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 12
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-17 | LOS: 1C1p
Materials Yield Variance
• Results from changes in the actual total quantity used for all types of materials compared with the planned quantity given the
actual output.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 13
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-18 | LOS: 1C1p

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 14
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-18 | LOS: 1C1p
(continued)

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 15
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-19 | LOS: 1C1p
(continued)

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 16
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-20 | LOS: 1C1o
Labor Mix Variance
• Usage of multiple labor rates for different workers requires dividing the labor efficiency variance into mix and yield variances.

• Labor mix variances result from changing the weighted average rate for labor due to changing the actual mix relative to the
standard mix.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 17
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-20 | LOS: 1C1p
Labor Yield Variance
• Labor yield variances result from changes in the actual total hours used by all classes of labor relative to the planned hours
allowed for the actual output.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 18
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-21 | LOS: 1C1p

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 19
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-21 | LOS: 1C1p
(continued)

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 20
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-22 | LOS: 1C1p
(continued)

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 21
of Becker Professional Education Corporation or the copyright owner.
Manufacturing
Overhead
Variances
C.1. Cost and Variance Measures: Part 2
Page 4-23 | LOS: 1C1m
Manufacturing Overhead: One-Way Variance

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 23
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-24 | LOS: 1C1m
Manufacturing Overhead: Two-Way Variance

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 24
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-25 | LOS: 1C1m
Manufacturing Overhead: Three-Way Variance

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 25
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-26 | LOS: 1C1m
Manufacturing Overhead: Four-Way Variance

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 26
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-29 | LOS: 1C1m

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 27
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-27 | LOS: 1C1r

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 28
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-27 | LOS: 1C1r
(continued)

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 29
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-28 | LOS: 1C1r
(continued)

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 30
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-28 | LOS: 1C1r
(continued)

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 31
of Becker Professional Education Corporation or the copyright owner.
C.1. Cost and Variance Measures: Part 2
Page 4-29 | LOS: 1C1r
(continued)

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 32
of Becker Professional Education Corporation or the copyright owner.
Variances for
Service
Companies
C.1. Cost and Variance Measures: Part 2
Page 4-32 | LOS: 1C1q
Variances for Service Companies
• Product costs include direct labor costs and overhead costs.

• Labor efficiency and rate variances are very useful, as spending more time than anticipated or paying a higher rate per hour
will produce unfavorable cost variances.

• Selling more services or charging higher rates than planned will produce favorable revenue variances.

• Sales mix and sales quantity variances are useful when the entity provides more than one service.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 34
of Becker Professional Education Corporation or the copyright owner.
Unit 4: 1C. Module 3
C.2. Responsibility
Centers
Types of
Responsibility
Centers
C.2. Responsibility Centers
Page 4-37 | LOS: 1C2a
Types of Responsibility Centers
• Responsibility centers = strategic business units (SBUs)

• SBUs are classified into four groups based on how managers are held accountable for financial performance:

─ Cost Center: performance based on controlling costs

─ Revenue Center: performance based on generating revenues

─ Profit Center: performance based on managing both revenues and costs

─ Investment Center: performance based on return on assets invested

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 3
of Becker Professional Education Corporation or the copyright owner.
C.2. Responsibility Centers
Page 4-38 | LOS: 1C2b

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 4
of Becker Professional Education Corporation or the copyright owner.
Reporting
Segments

5
C.2. Responsibility Centers
Page 4-38 | LOS: 1C2e
Reporting Segments
Responsibility centers can be subdivided into additional areas of accountability, including:

• Product lines or service

• Geographic areas

• Customers

• Process

• Time/Shifts

• Distribution channels (agent, wholesale, retail)

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 6
of Becker Professional Education Corporation or the copyright owner.
Responsibility
Center
Measurements
C.2. Responsibility Centers
Page 4-39 | LOS: 1C2c
Contribution Margin
• Measures the excess of revenues over variable costs

• Reflects the dollar amount available to cover fixed costs with the excess as profits

• Controllable margin by responsibility center = Contribution margin – Controllable fixed costs

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 8
of Becker Professional Education Corporation or the copyright owner.
C.2. Responsibility Centers
Page 4-40 | LOS: 1C2c, 1C2d

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 9
of Becker Professional Education Corporation or the copyright owner.
C.2. Responsibility Centers
Page 4-40 | LOS: 1C2g
Common Costs
• Common costs are the costs of support services, such as accounting, IT, and HR, that are shared by more than one
responsibility center.

• Common costs are uncontrollable costs.

• Common costs should be allocated among benefiting responsibility centers using one of the following methods:

─ Dual allocation

─ Stand-alone cost allocation

─ Incremental cost allocation

• Allocation of common costs links responsibility centers to the performance of the larger organization.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 10
of Becker Professional Education Corporation or the copyright owner.
C.2. Responsibility Centers
Page 4-41 | LOS: 1C2g
Common Cost Allocation: Dual Method
• The dual method, or dual pricing, allocates variable
overhead costs based on utilization and fixed overhead
costs according to capacity.

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 11
of Becker Professional Education Corporation or the copyright owner.
C.2. Responsibility Centers
Page 4-42 | LOS: 1C2g
(continued)

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 12
of Becker Professional Education Corporation or the copyright owner.
C.2. Responsibility Centers
Page 4-43 | LOS: 1C2g
Common Cost Allocation: Stand-Alone Method
• Each user department is allocated part of the common costs
based on usage.

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 13
of Becker Professional Education Corporation or the copyright owner.
C.2. Responsibility Centers
Page 4-44 | LOS: 1C2g
(continued)

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 14
of Becker Professional Education Corporation or the copyright owner.
C.2. Responsibility Centers
Page 4-44 | LOS: 1C2g
Common Cost Allocation: Incremental Method
• The largest department (primary user) is allocated all the costs it would bear if it was the only department.

• All fixed common costs and a portion of the variable costs go to the primary user, with the remaining variable costs allocated
to the other departments.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 15
of Becker Professional Education Corporation or the copyright owner.
C.2. Responsibility Centers
Page 4-45 | LOS: 1C2f
Issues With Common Cost Allocation
• Common costs do not cease to occur because a segment is discontinued.

• All common costs should be allocated to the segments and are factored into the prices charged to customers.

• Allocation of centralized departmental costs to benefitting segments should be fair, reasonable, and transparent.

• Segment managers cannot control the common costs allocated to their areas.

• Systems and training are required for staff to gather the information needed to allocate common costs equitably.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 16
of Becker Professional Education Corporation or the copyright owner.
Unit 4: 1C. Module 4
C.2. Transfer Pricing
Transfer Pricing
C.2. Transfer Pricing
Page 4-47 | LOS: 1C2h
Transfer Pricing Defined
• Involves setting a price for a product or service when an exchange occurs between different units within the
same organization

• Most relevant within vertically integrated organizations where one department produces component units
(intermediary products) used by another department

• Used to determine departmental operating income

• Has no impact on financial statements because these transactions are eliminated in a consolidated presentation

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 3
of Becker Professional Education Corporation or the copyright owner.
C.2. Transfer Pricing
Page 4-48 | LOS: 1C2h

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 4
of Becker Professional Education Corporation or the copyright owner.
C.2. Transfer Pricing
Page 4-48 | LOS: 1C2h
Transfer Pricing Objectives
Transfer pricing helps managers achieve the objectives of the company in the following ways:

• Reduces costs for purchasing department because internal purchases are typically made at below-market prices

• Allows excess capacity in one department to be redeployed to another department

• Increases overall performance through faster delivery of higher-quality products

• Drives coordination among the finance department (to help with pricing), the marketing department (to assess market prices
and quality), and the production department (to negotiate the prices)

• Creates synergies among departments, as companies can better use technology, knowledge, and production methods

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 5
of Becker Professional Education Corporation or the copyright owner.
Transfer
Pricing
Methodologies
C.2. Transfer Pricing
Page 4-50 | LOS: 1C2i
Transfer Pricing Methodologies
The five recognized transfer pricing methods are:

• Variable cost

• Full cost

• Market price

• Negotiated price

• Dual-rate pricing

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 7
of Becker Professional Education Corporation or the copyright owner.
C.2. Transfer Pricing
Page 4-50 | LOS: 1C2i
Variable Cost Method
• Transfer price is set equal to the incremental variable costs incurred by the selling unit

• Advantages

─ Useful when the division is operating below full capacity

─ Incentivizes managers to buy internally

• Disadvantages

─ Fixed costs are not covered, resulting in a loss to the selling division

─ Losses may reflect negatively on the performance of selling department managers

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 8
of Becker Professional Education Corporation or the copyright owner.
C.2. Transfer Pricing
Page 4-52 | LOS: 1C2i
Transfer Pricing Calculations: Full Cost Method
• Transfer price set equal to variable cost per unit plus fixed costs of the selling unit

• Advantages

─ Useful when SBUs are cost centers and all costs must be covered

─ Easy to implement and understand

─ Preferred by taxing authorities

• Disadvantages

─ Standard costs must be used to avoid potential price manipulation

─ Standard costs require selling division to bear all inefficiencies

─ Using actual costs may lead to inefficiencies of the selling division transferred to the buying division

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 9
of Becker Professional Education Corporation or the copyright owner.
C.2. Transfer Pricing
Page 4-52 | LOS: 1C2i
Transfer Pricing Calculations: Market Price Method
• Transfer price is the current external selling price between willing buyers and sellers

• Advantages

─ Optimal method when the market is well-established

─ Easier to comply with arm's-length transaction standards

─ Incentives for units to remain autonomous and maintain competitive pricing

• Disadvantages

─ Market prices may not be readily available

─ External supplier discounts not recognized

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 10
of Becker Professional Education Corporation or the copyright owner.
C.2. Transfer Pricing
Page 4-52 | LOS: 1C2i
Transfer Pricing Calculations: Negotiated Price Method
• Transfer price established as a negotiation between the purchasing manager and the selling manager

• Advantages

─ Practical and honest approach

─ Works well when market information is available and known

• Disadvantages

─ Related party negotiations may not meet arm's-length standards

─ Potential asymmetric power and experience between sides

─ Time-consuming

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 11
of Becker Professional Education Corporation or the copyright owner.
C.2. Transfer Pricing
Page 4-53 | LOS: 1C2i
Transfer Pricing Calculations: Dual Pricing Method
• Selling department records the sale at the market price and buying department records the purchase at variable cost

• Advantages

─ Both departments benefit: the seller earns a profit and the buyer minimizes costs

─ Encourages internal transfers because profit is shared between departments

• Disadvantages

─ Adds complexity to the accounting records

─ Transfers must be eliminated at their original prices, causing the creation of a pending account until the transactions are
reduced to zero

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 12
of Becker Professional Education Corporation or the copyright owner.
C.2. Transfer Pricing
Page 4-54 | LOS: 1C2j

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 13
of Becker Professional Education Corporation or the copyright owner.
C.2. Transfer Pricing
Page 4-54 | LOS: 1C2j
(continued)

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 14
of Becker Professional Education Corporation or the copyright owner.
C.2. Transfer Pricing
Page 4-54 | LOS: 1C2j
(continued)

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 15
of Becker Professional Education Corporation or the copyright owner.
C.2. Transfer Pricing
Page 4-54 | LOS: 1C2j
(continued)

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 16
of Becker Professional Education Corporation or the copyright owner.
Special Issues in
Transfer Pricing
C.2. Transfer Pricing
Page 4-56 | LOS: 1C2k
Outside Suppliers and Opportunity Costs
• The overall profit margin for a company is negatively impacted when outside suppliers who charge more than an internal
department are used.

• Transfer prices should not be set higher than market prices.

• Decision rule for an acceptable transfer price:

• Internal negotiations are needed to determine a fair price for both departments.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 18
of Becker Professional Education Corporation or the copyright owner.
C.2. Transfer Pricing
Page 4-57 | LOS: 1C2k

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 19
of Becker Professional Education Corporation or the copyright owner.
Effect of
International
Operations on
Transfer Pricing
C.2. Transfer Pricing
Page 4-58 | LOS: 1C2l
Operational and Transactional Issues That Impact Transfer Pricing
• Expropriation: the risk of foreign governments seizing a multinational corporation's (MNCs) assets may lead a department in
an area with high risk of expropriation to lower its transfer prices and profits

• Minimization of Customs Charges and Tariffs: lower transfer prices reduce the customs charges and tariffs to be paid by the
importing department

• Currency Restrictions: lower transfer prices limit foreign subsidiary profits and reduce/eliminate earnings restrictions

• Exchange Rate Fluctuation: managers may set transfer prices designed to protect the company from fluctuations in
exchange rates

• Availability of Skills and Materials: the availability of skills and materials in a country may impact transfer prices

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 21
of Becker Professional Education Corporation or the copyright owner.
C.2. Transfer Pricing
Page 4-58 | LOS: 1C2l
Arm's-Length Test: Taxation
• The Organization for Economic Co-operation and Development's model treaty establishes transfer prices using an
arm's-length test.

• Transfer prices between units should be valued in the same manner as third-party transactions to avoid undervaluing
transactions in order to reduce taxes.

• Acceptable Methods

─ Comparable Price Method: transfer prices set using the market prices for unrelated firms

─ Resale Price Method: transfer price set as the sale price less the markup associated with unrelated parties

─ Cost-Plus Method: transfer price is set as the cost of production plus normal markup

─ Advance Pricing Agreements (APAs): transfer prices set in an agreement between MNC and taxing authorities

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 22
of Becker Professional Education Corporation or the copyright owner.
C.2. Transfer Pricing
Page 4-59 | LOS: 1C2l

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 23
of Becker Professional Education Corporation or the copyright owner.
Unit 4: 1C. Module 5
C.3. Performance
Measures: Part 1
Performance
Measures
C.3. Performance Measures: Part 1
Page 4-61 | LOS: 1C3a
Performance Measures: Alignment With Strategy
• Operational goals and objectives for an entity should align with its strategic objectives.

• Individual employee performance should be evaluated relative to goals and objectives for the entity overall.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 3
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-62 | LOS: 1C3a
Performance Assessment
• Involves identifying measures (drivers) of success and tracking performance against those measures

• Measures (both financial and nonfinancial) should be quantifiable

• Examples of drivers include:

─ Productivity ─ Capacity utilization

─ Quality ─ Innovation and internal processes

─ Inventory management ─ Human resource management

─ Preventive maintenance

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 4
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-62 | LOS: 1C3a
Employee Feedback
To be effective, feedback should be:

• Tangible and actionable

• Aligned with goals

• User-friendly and transparent

• Timely

• Ongoing

• Consistent

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 5
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-63 | LOS: 1C3b
Product Profitability Analysis
• Used to evaluate profitability for a product or products at a point in time or over a given period of time

• Unprofitable products may need to be discontinued or repriced with potential adjustments to the production process

• Marginal (incremental) costs and opportunity costs must be analyzed to determine whether to continue to invest resources

• Factors to incorporate into the analysis include:

─ Contribution margin

─ Avoidable fixed costs

─ Reallocating capacity for another more profitable purpose

─ Impact on sales revenue of other products (loss leaders may attract customers to profitable products)

─ Impact on employee morale

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 6
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-63 | LOS: 1C3b
Business Unit Profitability Analysis
• Higher-level decisions made regarding continuing operations or closing segments or units

• Decision point involves comparing avoidable fixed costs to lost contribution margins from dropping a segment

─ Keep the segment if: lost contribution margin > avoidable fixed costs

─ Drop the segment if: lost contribution margin < avoidable fixed costs

• Factors to incorporate into the analysis are the same as the factors for product profitability analysis

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 7
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-64 | LOS: 1C3b
Customer Profitability Analysis
• Used to understand profitable customers and the resources consumed by each customer

• Helps management identify customers who contribute the most to operating income and should therefore receive the
most attention

• Customers who contribute low margins or are unprofitable should be converted into profitable customers or eliminated

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 8
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-64 | LOS: 1C3b
Challenges With Profitability Assessments
• It may be difficult to accurately measure costs.

• Whereas direct costs are easily measured and attributable to an individual unit, product, or customer, indirect (overhead)
costs must be allocated using cost drivers.

• Investment decisions require accurate assessments of resources and the timing and amount of resources needed.

• Valuation of assets and liabilities assigned in business unit profitability analysis can be challenging.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 9
of Becker Professional Education Corporation or the copyright owner.
Conducting
Profitability
Analysis
C.3. Performance Measures: Part 1
Page 4-64 | LOS: 1C3b
Product Profitability Analysis
• Performed by matching product revenues with product costs

• Crucial considerations:

─ Allocation of fixed costs

─ Determining whether fixed costs are avoidable or unavoidable

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 11
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-65 | LOS: 1C3c

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 12
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-65 | LOS: 1C3c

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 13
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-64 | LOS: 1C3b
Business Unit Profitability Analysis
• Performed by matching business unit revenues and costs

• Crucial considerations:

─ Allocation of fixed costs

─ Determining whether fixed costs are controllable by unit managers

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 14
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-66 | LOS: 1C3c

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 15
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-66 | LOS: 1C3c
(continued)

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 16
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-67 | LOS: 1C3d
Customer Profitability Analysis: Steps
1. Divide the customer base into segments (product, geography, demographics, customer needs).

2. Calculate total revenue by segment.

3. Allocate direct and indirect overhead costs to each segment and determine the contribution margin by customer.

4. Analyze customer segments to determine relative customer profitability.

5. Decide which customers to focus efforts on and which to let go.

6. Review strategies to evaluate the overall effect on company profitability.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 17
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-68 | LOS: 1C3c

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 18
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-68 | LOS: 1C3c
(continued)

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 19
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-68 | LOS: 1C3c
(continued)

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 20
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-69 | LOS: 1C3d
Profitability Analysis: Advantages and Disadvantages
• Advantages

─ Maximizing time and resources away from unprofitable areas and toward profitable ones

─ Better understanding of costs for products, units, and customers

─ Better data analysis helps managers understand long-term profitability and make informed decisions

• Disadvantages

─ High costs to invest in systems that capture data

─ Challenging to implement advanced management and cost accounting techniques

─ Risk of dropping unprofitable products or services to the detriment of customers

─ Long time period required to truly benefit from profitability analysis

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 21
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-69 | LOS: 1C3d
Profitability Analysis: Nonfinancial Factors
Nonfinancial factors should be considered before discontinuing a product line, business unit, or relationship with a
customer, including:

• Growth and long-term potential

• Market share potential

• Marketing and advertising

• Resource alignment

• Leadership and management

• Customer loyalty

• Network

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 22
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 1
Page 4-70 | LOS: 1C3d
Results of Profitability Analysis
As a result of profitability analysis, managers may:

• Change the pricing structure

• Identify products to promote

• Identify the focus of promotional efforts

• Identify customer segments to target and maintain

• Identify which customers, products, or business units to target for improvement and growth

• Take action regarding unprofitable products, business units, or customers

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 23
of Becker Professional Education Corporation or the copyright owner.
Unit 4: 1C. Module 6
C.3. Performance
Measures: Part 2
Measures of
Profitability
C.3. Performance Measures: Part 2
Page 4-74 | LOS: 1C3e
Return on Investment (ROI)
• Assessment of percentage return relative to the level of assets

• Good performance measure for investment SBUs

For CMA Exam purposes, the above formula is equivalent to ROI as defined by the IMA.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 3
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-74 | LOS: 1C3e
Return on Investment (ROI)—Alternative Formula
• Alternative terms can be used in the ROI formula depending on what aspects of performance companies aim to measure

─ In the numerator, ROI may be calculated using net income (income after taxes) instead of operating income
─ In the denominator, ROI may be calculated using the amount of investment capital instead of total assets

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 4
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-80 | LOS: 1C3f

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 5
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-80 | LOS: 1C3f
(continued)

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 6
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-75 | LOS: 1C3i
ROI: Benefits and Limitations
• Benefits

─ Relatively easy to calculate

─ Useful when measured against a hurdle rate

─ Used to compare performance over several accounting periods

• Limitations

─ Short-term focus

─ Potentially misleading due to differences in accounting policies or valuation methods

─ Additional investments increase the denominator and lower the ratio, creating a disincentive to invest in new assets

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 7
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-75 | LOS: 1C3e
Return on Equity (ROE)
• Measure of how effectively investor capital is used to produce shareholder value

• Can be computed using a basic calculation (below) or more detailed calculations (DuPont variations)

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 8
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-77 | LOS: 1C3e
Return on Equity (ROE): DuPont Formula

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 9
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-78 | LOS: 1C3e
Return on Equity (ROE): Extended DuPont Formula

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 10
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-78 | LOS: 1C3e

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 11
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-79 | LOS: 1C3e
(continued)

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 12
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-81 | LOS: 1C3g
Residual Income
• Used to measure the excess of operating income earned over the return required

For CMA Exam purposes, the above formula is equivalent to residual income as defined by the IMA.
An alternative calculation is net income minus required return, where required return equals equity times the hurdle rate.

• Rate of return (hurdle rate) options: WACC, cost of equity, or a target return

• Performance measure for investment SBUs

• Positive = Meeting standards

• Negative = Not meeting standards

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 13
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-81 | LOS: 1C3h

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 14
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-82 | LOS: 1C3i
Residual Income: Benefits and Limitations
• Benefits

─ Profitability measure based on dollars, not percentages

─ Straightforward interpretation

• Limitations

─ Target rate of return highly subjective

─ Comparisons are distorted due to dollar comparisons of units that may differ in size

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 15
of Becker Professional Education Corporation or the copyright owner.
Measurement
Issues Affecting
Profitability
C.3. Performance Measures: Part 2
Page 4-82 | LOS: 1C3j
Revenue and Expense Recognition
• Performance evaluation is used to compare entities to standards and to each other.

• Comparability may be inhibited by the following revenue and expense recognition issues:

─ Non-recurring items that distort income

─ Large investments in advertising and promotions for a new product

─ Significant gains on asset dispositions

─ Differing methods of depreciation

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 17
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-83 | LOS: 1C3k
Other Measurement Issues
• Differences in inventory costing methodologies (LIFO, FIFO, weighted average, etc.)

• Cost allocation methodologies used for joint assets shared among departments

• Variations in the value of assets used in rate-of-return calculations

• Differences in asset capitalization policies and thresholds

• Using full absorption costing versus variable costing

• Disposition of variances may be entirely to COGS or prorated between COGS, WIP inventory, and finished goods inventory

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 18
of Becker Professional Education Corporation or the copyright owner.
Balanced
Scorecards (BSC)
C.3. Performance Measures: Part 2
Page 4-83 | LOS: 1C3m
Balanced Scorecard
• Used to gather information on multiple dimensions of an organization's performance.

• Describes the classifications of the critical success factors, strategic goals, tactics, and related measures.

• The strategy of the company must be the core of the scorecard.

• Only the most critical measures should be included (related to KPIs).

• Balance needed between short-term and long-term sustainability.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 20
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-83 | LOS: 1C3n
Balanced Scorecard: Critical Success Factors
Financial

• Financial Measures: ROA, ROI, profit margins, turnover ratios, etc.

Nonfinancial

• Internal Business Processes: measures of quality and efficiency

• Customer Satisfaction: measures related to customer retention, repeat visits, etc.

• Advancement of Innovation and Human Resource Development: measures focused on training and development
of personnel

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 21
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-85 | LOS: 1C3o
Balanced Scorecard: Successful Implementation
• Balanced scorecard should be used for measuring performance and setting rewards.

• Top-level managers must be committed to leading the process.

• Scorecard objectives should be in part based on employee feedback.

• The scorecard should be communicated to all employees within an organization.

• Employees should understand the links between the different perspectives on the scorecard.

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 22
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-84 | LOS: 1C3q

(continued)
The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 23
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-85 | LOS: 1C3q
(continued)

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 24
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-86 | LOS: 1C3p
Strategy Map
• Graphical depiction of a company's strategy

• Used to evaluate and review progress toward the achievement of strategic objectives

• Outlines overall strategic goals and helps employees see where they fit in the achievement of overall goals

• Often linked to the four perspectives of the balanced scorecard

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 25
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-86 | LOS: 1C3p

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 26
of Becker Professional Education Corporation or the copyright owner.
Key Performance
Indicators
C.3. Performance Measures: Part 2
Page 4-87 | LOS: 1C3l
Key Performance Indicators (KPI)
• Key indicators of progress toward objectives and priorities as established in the strategic plan

• KPIs are used to focus management on strategic and operational improvement

• Can be quantitative or qualitative

• Should link to the measures in the balanced scorecard:

─ Financial Perspective Indicators: growth in sales, profit margins, ROI

─ Internal Business Process Indicators: throughput time, percentage of defective items

─ Customer Satisfaction Perspective: counts of repeat and new customers, wait times

─ Learning and Growth Perspective: employee innovation and knowledge

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 28
of Becker Professional Education Corporation or the copyright owner.
C.3. Performance Measures: Part 2
Page 4-87 | LOS: 1C3r
Recommended Measures and Methodologies
• There should be alignment between performance measurement methods used and an entity's strategic goals and objectives.

• Goals are used to define the types of measures needed to evaluate performance.

• Examples of financial and operational goals:

─ Grow market share by 5 percent over the next 3–5 years

─ Entity ROA > Industry ROA by 2 percent annually

─ Positive residual income of $100,000

─ Sales growth > 5 percent per year

─ Reduce processing time by 15 percent

─ Reduce expected delivery time to customers by 20 percent

The copyright in this material is owned by Becker Professional Education Corporation, or where specifically indicated, by the original creator of the material. None of this material may be
© Becker Professional Education Corporation. All rights reserved. copied, reproduced, republished, or displayed in any form or by any means, including, but not limited to, electronic, mechanical, photocopying, or otherwise, without the prior written permission 29
of Becker Professional Education Corporation or the copyright owner.