MODULE 2, ASSIGNMENT 4

December 12, 2011

Topic: Standard Costing, Variance Analysis and Budgets

Overview The main topics for Assignment 4 are standard costing, variance analysis, and budget creation. Accountants of all management levels often have to analyze variance reports in order to help in the decision-making process. Through the differentiation of costs into fixed and variable classifications, managers are better able to construct break-even charts and other decision-making and control tools. Understanding cost breakdown can better determine where the inefficiencies of the operations lie, and determine the first step towards enhancing the efficiency of an operation. In addition, cost analysis helps toward the creation of budgets and forecasts. An effective budget or forecast is necessary for an organization to make optimal use of the resources available to it. Variance analysis reports are very predominant in manufacturing organizations. When variance analysis is conducted properly (e.g., on time and at the proper level), it can be an effective control against further cost and schedule problems that may jeopardize the successful completion of a product. In this assignment, candidates will learn why standard cost systems are used, how standards for material and labour are set, how material, labour and overhead variances are calculated, and how desired levels of attainability affect standard settings. Learning Outcome The candidates will interpret the results of a variance analysis report in order to evaluate performance against targets and use this information as a means for planning and control when preparing an operating budget. Due Date Please refer to the Schedule accessed from the left navigation menu.

2011 The Society of Management Accountants of Canada. All rights reserved. / Registered Trade-Marks/Trade-Marks are owned by The Society of Management Accountants of Canada. No part of this document may be reproduced in any form without the permission of the copyright holder.

Required Readings 1. Cost Accounting: A Managerial Emphasis, 5th Canadian Edition. Authors: Horngren, Foster, Datar, Teall and Gowing, Chapter 16, pages 790-803, located in the Online Library. Assignment Complete the following assignment, which will be submitted to the website for your moderator to review. Further discussion on this assignment will take place at the IS. An assessment rubric for this assignment is provided in Appendix 1. M2A4 New Look Jacket Inc. Read the case entitled New Look Jacket Inc. located below. Required: Candidates are required to analyze a variance analysis report and create a draft operating budget for their moderators review. The analysis should explain the reasons for each variance contained in the variance report and interpret the numbers of the variance report as it relates to the situation at New Look Jacket. They will use this analysis as a basis for a problem-solving and decision-making exercise at the Interactive Session. The introduction, body and conclusion of the report must be no longer than 1,000 words and there may be up to four pages of appendices.* Tables and exhibits included in the body of the report (instead of as appendices) will be included in the word count. Please work with the variances provided in the exhibits. * Each assignment has length specifications, defined in words and/or pages. Markers will mark only the content within the specified length.

Format Specifications Refer to the Format Specifications section of the Year 1 CMA Case Writing Reference Guide located in the Reference Material section of the Professional Programs website. Collaboration and Plagiarism Researching ideas from published materials and sharing ideas with other candidates is a legitimate approach to learning. However, this is an individual assignment and each candidate must prepare his/her own original response that reflects independent thoughts (e.g. independent applications of ideas) and original writing. Candidates may not copy any part of their response from work done by another candidate. In applying concepts from CMA Canada Professional Programs readings and other published

CMA Canada

sources, copied material and application of another authors original ideas must be appropriately referenced. Violating these rules will be considered plagiarism. Candidates committing plagiarism are subject to provincial penalties and disciplinary measures. CMA Canadas Policy on Plagiarism can be found within the Year 1 CMA Case Writing Reference Guide located in the Reference Material section of the Professional Programs website. Posting the Assignment 1. Use the assignment reference number M2A4 plus your member number in the file name and on each page of your report. 2. Do not include your name in the file name or in your report. 3. Post the file from the same page where you accessed this Assignment, using the Browse and Submit functions found there. 4. Post the file by the due date. 5. Refer to the Candidate Website Manual, Section 9, for further details.

CMA Canada

New Look Jacket Inc.

In early 2012, the CEO of the New Look Jacket Inc. (NLJ) was reviewing the 2011 operating results (see Exhibit 1). He was pleased to see that sales and net income were higher than the budget, but he had a feeling that the aggregated numbers were hiding some information. He decided to call in the companys newly hired controller, a Certified Management Accountant, to ask for a variance analysis. NLJ produces and sells two lines of jackets: nylon and leather. The market for nylon jackets is large and competitive, but the leather jacket market has traditionally been small with only a few competing manufacturers. During 2011, fashion trendsetters highlighted leather jackets, creating a ten-time increase in the markets demand for leather jackets. Unfortunately, NLJ did not foresee this trend and had planned sales of only 5,000 leather jackets in the 2011 budget (see Exhibit 1). While the increased demand for leather jackets created a windfall gain in sales for NLJ, it created great turmoil in the production plant. Supply of direct materials had been contracted at the beginning of the year based on the budgeted requirements. NLJs buyers had to purchase the increased requirements for leather from various new sources, some of which proved to be unreliable. Workers skilled in cutting and sewing leather were scarce and the production manager had to hire and train inexperienced workers. Also, three new special sewing machines had to be purchased. In late December 2011, the production manager reported to the CEO that, despite the many necessary adjustments that were made during the year, he managed to fill all orders for both lines of jackets. He was proud of his departments performance and requested that sizeable bonuses be awarded to all production workers and staff. Hearing about the production managers request, the marketing manager asked to speak with the CEO. Marketing Manager: I hear that the production manager has been boasting about his departments performance this year. Sure, he filled all of the orders, but deliveries were usually two to four weeks late and eight percent of the leather jackets were sent back for replacement because of flaws, sizing errors and inferior quality of leather. Weve built our reputation on good service and quality products. Weve never been late on deliveries before and returns have always been less than 1%. Im afraid were going to lose some of our longstanding customers if we dont get our service and quality back to our usual standards.

CMA Canada

CEO: The production manager admitted to having quality control problems because the experienced leather workers did not have the time to adequately train and supervise the new inexperienced workers who were hired. However, he assured me that the new workers need only another month or two to perfect their skills and get up to speed. Marketing Manager: Well, I hope so. The fashion trend for leather jackets is expected to surpass last year and, if we can deliver good quality jackets on time, I think we can sell up to 30,000 leather jackets in 2012. After his meeting with the marketing manager, the CEO met with the new controller. The CEO described his conversations with both the production and marketing managers and then requested the following information from the controller: 1. A written explanation of the significance and reasons for the variances in the 2011 detailed variance report (Exhibit 2); and 2. A draft operating budget for 2012. The controller immediately collected data from the marketing and production managers on which to base the 2012 budget (see Exhibit 3). Candidates are expected to address all the Required. Failure to do so may result in an assessment of Below Expectations or Not Addressed.

CMA Canada

Exhibit 1 New Look Jacket Inc. 2011 Operating Budget Nylon Jackets Sales volume Sales revenue Direct materials Direct labour Variable overhead Variable selling and admin. Total variable costs Contribution margin Fixed overhead Fixed selling and admin. Net income 95,000 $3,325,000 665,000 760,000 570,000 166,250 2,161,250 $1,163,750 Leather Jackets 5,000 $750,000 250,000 200,000 30,000 37,500 517,500 $232,500 Total 100,000 $4,075,000 915,000 960,000 600,000 203,750 2,678,750 1,396,250 900,000 250,000 $ 246,250

New Look Jacket Inc. 2011 Actual Operating Results Nylon Jackets Sales volume Sales revenue Direct materials Direct labour Variable overhead Variable selling and admin. Total variable costs Contribution margin Fixed overhead Fixed selling and admin. Net income 93,500 $3,272,500 654,500 748,000 561,000 149,600 2,113,100 $1,159,400 Leather Jackets 16,500 $2,475,000 935,550 726,000 115,500 140,250 1,917,300 $ 557,700 Total 110,000 $5,747,500 1,590,050 1,474,000 676,500 289,850 4,030,400 1,717,100 1,000,000 300,000 $ 417,100

CMA Canada

Exhibit 2 2011 Detailed Variance Report Sales price Sales volume: Mix Quantity* Total sales volume *Sales Quantity Variance: Market share Market size Total Direct materials: Price Usage Total direct materials Direct labour: Rate Usage Total direct labour Variable overhead Variable selling and admin. Fixed overhead Fixed selling and admin. Total variance from budget Nylon Jackets 0 $134,750 U 116,375 F $ 18,375 U Leather Jackets 0 $511,500 F 23,250 F $534,750 F Total 0 $376,750 F 139,625 F $516,375 F

$349,063 U $488,688 F $139,625 F

0 0 0

$ 44,550 U 66,000 U $110,550 U

$ 44,550 U 66,000 U $110,550 U

0 0 0 0 $ 14,025 F

$ 99,000 F 165,000 U $ 66,000 U $ 16,500 U $ 16,500 U

$ 99,000 F 165,000 U $ 66,000 U $ 16,500 U $ 2,475 U

$100,000 U $ 50,000 U $170,850 F

CMA Canada

Exhibit 3 Marketing and Production Data Nylon Jackets Market size (units): 2011 budget 2011 actual 2012 estimate Expected market share for 2012 Estimated sales price for 2012 2011 production standards: Direct material quantity Standard price/metre Direct labour hours Standard rate/hour Standard variable overhead cost Variable selling and admin. 475,000 425,000 400,000 25% $37.00 2.8 metres $2.50 1 hour $8.00 $6.00 $1.75 Leather Jackets 12,500 125,000 150,000 20% $160.00 2.5 metres $20.00 2 hours $20.00 $6.00 $7.50

For nylon jackets, all budgeted estimates were achieved with the exception of sales volume and variable selling and administration. Unit variable costs for nylon jackets and all fixed costs are expected to increase by 5% over the 2011 actual costs because of inflation. For leather jackets, variable cost and usage standards were revised as follows to more closely reflect expected conditions: 2011 Actual 2.7 metres $21.00 2.5 hours $17.60 $7.00 $8.50 Revised 2012 Standard 2.6 metres $23.00 2.2 hours $20.00 $7.25 $9.00

Direct material quantity Direct material price per metre Direct labour hours Direct labour rate/hour Variable overhead Variable selling and admin.

CMA Canada

Appendix 1 Assessment Rubric for Business Application Reports The difference between ME+ and ME- depends on the quality of the response.
Component 1. Qualitative Analysis and Strategy Formulation Employs analytical problem-solving skills for a defined business problem or issue in a systematic manner as follows: 1. Demonstrates their understanding of the problem or issue; 2. Provides research in support of their argument; and 3. Makes observations/recommendations based on an integrated view of the best outcome. ME: All the above elements are BE: One or two of the above AE: All the above elements are elements are missing and/or the contained in the assignment. contained in the assignment. claims made in the body of the The central argument is The ideas presented reflect a assignment do not support the demonstrated but not entirely robust understanding of the central argument. Little clear and/or lacks strong required and clearly support the connection made between the support. Demonstrates central argument. Clearly assignment and required connections between the connects their ideas to some readings. argument and key ideas of the central themes contained within required readings. the required readings. ME+ ME ME-

Component 5. Recommendations and Conclusions Presents ideas, arguments and recommendations in a logical, supportive and convincing manner. BE: Little or no evidence ME: Presents a logical AE: Position is supported in provided in support of their argument, but some of the depth with a variety of sources. argument. Ideas presented did evidence used does not support Information is relevant and the claims made and/or may not not address the required original supports the writers ideas. be relevant. Provides concluding discussion question or prior Provides concluding thoughts post(s) presented. thoughts. that clearly summarize their position. ME+ ME ME-

Component 6. Professionalism and Communication The format and organization of the report are appropriate: 1. The ideas expressed are communicated in a clear and concise manner; 2. Adheres to the specified length limit; 3. A professional tone is used. BE: An element is missing, or ME: Most of the elements are AE: All the above elements are there are major problems with present but there may be some present. Ideas are expressed more than two elements. The minor problems with one or two. logically and coherently reader cannot follow the The reader can follow the throughout the discussion. The structure of the argument. reader can effortlessly follow the structure of the argument with little difficulty. argument presented. ME+ ME ME-

CMA Canada