Calculating ROI and Residual income, Price Variance for raw material purchased

E 15.12

Calculating ROI and Residual income

Division A       Division B       Division C

Revenues                                             500,000           600,000           1000000         

Operating Income                               60,000             72,000             80,000

Operating Assets                                 250,000           600,000           500,000

Margin                                                 12%                 12%                 8%                              

Turnover                                              2                      1                      2

ROI                                                     24%                 12%                 16%

Residual Income                                 30000              0                      20,000

Working Note

For Division A                                                           

Margin                         =          operating income /Revenue                            = 12%

Turnover                      =          Revenue/Operating Assets                              = 2

ROI                             =          Operating Income / operating assets              = 24%

Residual Income         =          operating income-(operating assets *ROI)     = 30000

B.

Looking at the overall data of the division ‘A’ it can be understood that division A is the best performer among three division. Division A has 30,000 residual incomes and 24% ROI and turnover. On the other hand, Division C is also performing well but not as good as A and finally division B is least performer because it’s  Residual income is nill.

C.  For Division A, residual income is $30,000, which is positive, that means Division A is earning more than predetermined set of standard.
This allows the manager of Division
A to invest in new product line with a return of at least a 12%. Because any opportunity that
provided at least a 12% ROI would increase Division’s A residual income. Residual Income improves he decision making because it has enough fund to invest in some other project.

P15-14

Direct materials                                   3 lbs. @ $6.00/lb

Direct labor                             1.8 hrs.  @ $ 12.00/hr.

Variable Overhead                  0.6 hrs. @ $3.50/hr

A.

Calculating the Price Variance for raw material purchased

11400                                      11400

   *6.2                                        * 6

70680                                      68400

 Therefore the Price Variance is (70680-68400) =2280 U

Or,

11400(6.2-6) =2280 U

B

Calculating the Raw material usage variance

11290                                                  11400

       * 6                                                       *6   

67740                                                    68400

Therefore, the variance is 67740-68400 = 660 F

C

Calculating the Direct labor rate variance

6720                                                    6720

*12.25                                                 *12     

82320                                                  80640

Therefore, the labor rate variance is 82320-80640 = 1680 U

D

Calculating the Direct labor efficiency variance

6720                                                    6840

*12                                                      *12

80640                                                  82080

Therefore, the variance is 80640-82080 = 1140F

E

Variable overhead spending variance

2390                                                    2390

*3.4                                                     *3.5

8126                                                    8365   

Therefore, the variable overhead spending variance is 8126 – 8365 = 239 F

F

Calculating the variable overhead efficiency variance

2390                                                    2280

*3.5                                                     *3.5

8365                                                    7980

                                   

Therefore, the variable overhead efficiency variance is 8365- 7980 = 385 F

C 15.23

A

In my opinion, the purchasing manager may be purchasing low quality materials just because they are relatively less expensive or because the supplier is offering huge discount which may be the reason for unfavorable direct material usage variances. In addition to this direct laborers have complained about the quality of certain raw material items which obviously signify the purchasing manager’s inefficiency to buy high quality materials.

B

Performance report is used to communicate to upper level manager’s concise explanation of the causes of significant variances. Responsibility reporting is the best way to enhance the performance of each layer of management. Therefore, In this case, performance reporting system can be improved by communicating to the purchase manager as promptly as feasible about the low quality materials and its potential damage to the overall performance of the company. This is the only way that helps purchase manager easily understand the problem and take the appropriate action to overcome such problem by taking early initiative. In addition to this, Bennett inc. can predefine the material usage variance which works as a ceiling to purchase manager and work as a standard. And helps purchase managers to rate their own performance against the predetermined set of standard and take corrective action if there is any deviation.

Performance report must be issued soon after the period in which the activity takes place if they are to be useful for influencing future performance. This is the best way to link result to the actions that cause those results.