English for management accounting

Managerial Accounting
Topic 1. Job-order costing
Glossary
No
1
3
4
5
6
7
8
9

10

11

12

13
14

15
16

Terms
Allocation base

Meaning
A measure of activity such as direct labor-hours or machine-hours
that is used to assign costs to cost objects

Bill of materials
A document that shows the quantity of each type of direct material
required to make a product
Cost driver
A factor, such as machine-hours, beds occupied, computer time,
or flight-hours, that causes overhead costs
Cost
of
goods The manufacturing costs associated with the goods that were
manufactured
finished during the period
Finished goods
Units of product that have been completed but not yet sold to
customers
Job cost sheet
A form that records the materials, labor, and manufacturing
overhead costs charged to a job
Job-order costing
A costing system used in situations where many different
products, jobs, or services are produced each period
Materials requisition A document that specifies the type and quantity of materials to be
form
drawn from the storeroom and that identifies the job that will be
charged for the cost of those materials
Multiple
A costing system with multiple overhead cost pools and a
predetermined
different predetermined overhead rate for each cost pool, rather
overhead rates
than a single predetermined overhead rate for the entire company.

Each production department may be treated as a separate overhead
cost pool.
Normal cost system
A costing system in which overhead costs are applied to a job by
multiplying a predetermined overhead rate by the actual amount
of the allocation base incurred by the job
Over-applied
A credit balance in the Manufacturing Overhead account
overhead
that occurs when the amount of overhead cost applied to Work in
Process exceeds the amount of overhead
cost actually incurred
during a period
Overhead
The process of charging manufacturing overhead cost to job cost
application
sheets and to the Work in Process account
Predetermined
A rate used to charge manufacturing overhead cost to jobs that is
overhead rate
established in advance for each period. It is computed by dividing
the estimated total manufacturing overhead cost for the period by
the estimated total amount of the allocation base for the period
Raw materials
Any materials that go into the final product
A schedule that contains three elements of product
1


Schedule of cost

of goods
manufactured
17

18
19

20

costs—direct materials, direct labor, and manufacturing
overhead—and that summarizes the portions of those costs that
remain in ending Work in Process inventory and that are
transferred out of Work in Process into Finished Goods
Schedule of cost of A schedule that contains three elements of product costs—direct
goods sold
materials, direct labor, and manufacturing overhead — and that
summarize the portions of those costs that remain in ending
Finished Goods inventory and that are transferred out of Finished
Goods into Cost of Goods Sold
Time ticket
A document that is used to record the amount of time an employee
spends on various activities
Under-applied
A debit balance in the Manufacturing Overhead account
overhead
that occurs when the amount of overhead cost actually incurred
exceeds the amount of overhead cost applied to Work in Process
during a period
Work in process
Units of product that are only partially complete and will require

further work before they are ready for sale to the customer

Concepts in Action
1. Read and fill in the blanks with the following words: costing data, project variances,
unique, last-minute, profitable, identified, leverage, budgeted, cost, individually, pricing decisions,
direct labor-hours, completed, success, experience, grand opening, stages, estimated overhead costs,
allocation bases, the percentage
Job Costing on Cowboys Stadium
Over the years, fans of the National Football League have (1)
the Dallas
Cowboys as “America’s Team.” Since 2009, however, the team known for winning five Super
Bowls has become just as recognized for its futuristic new home, Stadium in Arlington, Texas.
When the Cowboys take the field, understanding each week’s game plan is critical for
(2)
But for Manhattan Construction, the company that managed the development
of the $1.2 billion Cowboys Stadium project, understanding costs is just as critical for making
successful (3)
, winning contracts, and ensuring that each project is
(4)
. Each job is estimated (5)
because the (6)
endproducts, whether a new stadium or an office building, demand different quantities of
Manhattan Construction’s resources.
In 2006, the Dallas Cowboys selected Manhattan Construction to lead the construction
of its 73,000 seat, 3 million- square-foot stadium. To be (7)
in three years, the
stadium design featured two monumental arches spanning about a quarter-mile in length over
the dome, a retractable roof, the largest retractable glass doors in the world (in each end zone),
canted glass exterior walls, 325 private suites, and a 600-ton JumboTron hovering 90 feet
above the field.

With only 7% of football fans ever setting foot in a professional stadium, “Our main
competition is the home media center,” Cowboys owner Jerry Jones said in unveiling the
stadium design in 2006. “We wanted to offer a real (8)
that you can’t have at
home, but to see it with the technology that you do have at home.”
2


Generally speaking, the Cowboys Stadium project had five (9)
: (1)
conceptualization, (2) design and planning, (3) preconstruction, (4) construction, and (5)
finalization and delivery. During this 40-month process, Manhattan Construction hired
architects and subcontractors, created blueprints, purchased and cleared land, developed the
stadium—ranging from excavation to materials testing to construction—built out and finished
interiors, and completed (10)
changes before the stadium’s
(11)
in mid-2009.
While most construction projects have distinct stages, compressed timeframes and
scope changes required diligent management by Manhattan Construction. Before the first game
was played, Manhattan Construction successfully navigated nearly 3,000 change requests and a
constantly evolving budget.
To ensure proper allocation and accounting of resources, Manhattan Construction
project managers used (12)
. The system first calculated the (13)
of
more than 500 line items of direct materials and labor costs. It then allocated (14)
(supervisor salaries, rent, materials handling, and so on) to the job using
direct material costs and (15)
as (16)

.
Manhattan Construction’s job-costing system allowed managers to track (17)
on
a weekly basis. Manhattan Construction continually estimated the profitability of the Cowboys
Stadium project based on (18)
of work completed, insight gleaned from
previous stadium projects, and revenue earned. Managers used the job-costing system to
actively manage costs, while the Dallas Cowboys had access to clear, concise, and transparent
(19)
.
Just like quarterback Tony Romo navigating opposing defenses, Manhattan
Construction was able to (20)
its job-costing system to ensure the successful
construction of a stadium as iconic as the blue star on the Cowboys’ helmets.
2. Listen and fill in the blanks

Making movie
Big Hollywood movies are fraught with costs of story writers, camera, equipment,
studio space, actors, even the right to shoot in a specific location like a famous restaurant has a
cost. (1)
is critical to the studio’s success because it helps them to (2)
such as what type of films to produce in the future? How much to charge for
DVD? and even figure out if the director is keeping to a film’s budget while it is being made.
(3)

involves the (4)
, (5)
and (6)
of
(7)

. From these data, companies can determine both (8)
and
(9)
of each product. There are two basic types of (10)
:
a job-order cost system and a process cost system. Under (11)
,a
company like a movie studio or an independent self – financed film maker assigns costs to
each job or in this case each movie produced. And an (12)
of job
order costing is that each job or batch has its own (13)
, it
measures costs for (14)
rather than for set time periods.
Heidi van Leer knows a lot about film costs. She ‘s not only a programmer for the
annual Slamdance Film Festival in Park City Ulta but in independent film maker herself. Heidi
3


van Leer:” production costs, especially the studio production they’re really used to spending a
lot of money on everything. In an independent film, I usually just try and feed my crew, pay for
my equipment, pay for stock and that’s about it”
Companies that manufacture large volumes of (15)
use a
(16)
which accumulates product related costs for (17)
such
as a quarter or year and assigns them to (18)
or processes. Job order
costing is more precise in assignment of costs to projects than process costing. However

recording the information is (19)
. Just the same, it isn’t unusual for a
company to use both systems . For example Jones Soda practices process costing when
manufacturing soda but uses job order costing when producing small custom orders for its my
Jones program.
Studios today must be more budget – conscious than ever that means maintaining a
good job order (20)
. The flow of costs (21)
, (22)
and
(23)
in job order cost accounting parallels the physical flow of
the materials as they are converted into finished goods. While a film is produced, the studio
accumulates (24)
through accurate record keeping and assigns those costs
to the account for each film as a (25)
. When the film is finished, they
transfer the cost to the film to finished good inventory. Later, when the film is sold or
distributed, they transfer the costs for that film to (26)
. So that they can
compare costs to the final revenues of the film to determine their profit.
Not all cost can be easily attributed to one section as the flow of material. Overhead
costs like studio executive office space cannot be assigned to specific jobs on the basis of
(27)
incurred. Instead companies assign costs to a work - in process into
specific jobs on an estimated basis to the use (28)______________________
In general, company across industries established a predetermined overhead rate
(29)____________________of the year. Small companies often use a single company – wide
predetermined overhead rate. Large companies often use rates that vary from department to
department. The formula for a predetermined

overhead rate is as follows:
(30)______________
divided by (31)
equals
Predetermined overhead rate. Overhead relates to production operations as a whole. To know
what the whole is, the logical thing is to wait until the end of the years operation. At that time,
the studio know all of its costs for the period. As a practical matter though, managers cannot
wait until (32)
. To price product accurately they need information
about product costs of (33)
completed during the year. Using a predetermined
overhead rate enables the cost to be determined for the job immediately.
Job order costing can be fairly (34)
and (35)
manufacturing
situations. But how costs are assigned to a movie is often (36)
and may be
subjected to (37)
. For example in Hollywood studios often negotiate
producer, director and actors payment based on a percentage of a films (38)
.
As a movie has gone to larger box office grosses it is not uncommon to see the various players
fighting over what they perceive to be their fair share.
Filmmaking has changed greatly in the last half century. Before 1917 it was nearly
impossible to do a film outside of a major studio. Technology has changed all that. But even
4


with new distribution channels like cable networks and the internet the overwhelming supply
of material has reduced the price, studio can pay for any individual film.

The (39)
of film both great and small is dependent upon the practices of a
careful (40)
.

Summary
Read and fill in the blanks with the following words: predetermined overhead rate,
labor time tickets, job-order costing, over-applied overhead, manufacturing overhead costs,
the actual overhead cost, materials requisition forms, the estimated total manufacturing
overhead cost, finished goods, the estimated total amount of the allocation base direct laborhours machine-hours, under-applied, cost of goods sold, work- in process

(1)
is used in situations where the organization offers
many different products or services, such as in furniture manufacturing, hospitals, and legal
firms. (2)
and (3)
are used to assign direct
materials and direct labor costs to jobs in a job- order costing system. (4)
are assigned to jobs using a (5)
. All of the costs
are recorded on a job cost sheet. The predetermined overhead rate is determined before the
period begins by dividing (6)
for the period by
(7)
for the period. The most frequently
used allocation bases are (8)
and (9)
.
Overhead is applied to jobs by multiplying the predetermined overhead rate by the actual
amount of the allocation base recorded for the job. Because the predetermined overhead rate is

based on estimates, (10 )
incurred during a period may be more or
less than the amount of overhead cost applied to production. Such a difference is referred to as
(11)
or (12)
. The under-applied or over-applied
overhead for a period can be either closed out to (13)
or allocated
between (14)
, (15)
, and Cost of Goods Sold.
When overhead is under-applied, manufacturing overhead costs have been understated and
therefore inventories and/or expenses must be adjusted upwards. When overhead is overapplied, manufacturing overhead costs have been overstated and therefore inventories
and/or expenses must be adjusted downwards.

Questions
1.
Why aren’t actual manufacturing overhead costs traced to jobs just as direct materials
and direct labor costs are traced to jobs?
2.
Explain the four-step process used to compute a predetermined overhead rate.
3.
What is the purpose of the job cost sheet in a job-order costing system?
4.
Explain how a sales order, a production order, a materials requisition form, and a labor
time ticket are involved in producing and costing products.
5.
Explain why some production costs must be assigned to products through an allocation
process.
6.

Why do companies use predetermined overhead rates rather than actual manufacturing
overhead costs to apply overhead to jobs?
5


7.
What factors should be considered in selecting a base to be used in computing the
predetermined overhead rate?
8.
If a company fully allocates all of its overhead costs to jobs, does this guarantee that a
profit will be earned for the period?
9.
What account is credited when overhead cost is applied to Work in Process? Would
you expect the amount applied for a period to equal the actual overhead costs of the period?
Why or why not?
10.
What is under-applied overhead? Over-applied overhead? What disposition is made of
these amounts at the end of the period?
11.
Provide two reasons why overhead might be under-applied in a given year.
12.
What adjustment is made for under-applied overhead on the schedule of cost of goods
sold? What adjustment is made for over-applied overhead?
13.
What is a plant-wide overhead rate? Why are multiple overhead rates, rather than a
plant - wide overhead rate, used in some companies?
14.
What happens to overhead rates based on direct labor when automated equipment
replaces direct labor?

Topic 2. Process costing
Glossary
No
1
2

3

4
5
6
7
8

Terms
Conversion cost
Equivalent units

Meaning
Direct labor cost plus manufacturing overhead cost
The product of the number of partially completed units and their
percentage of completion with respect to a particular cost. Equivalent
units are the number of complete whole units that could be obtained
from the materials and effort contained in partially completed units
Equivalent units of The units transferred to the next department (or to finished goods)
production
during the period plus the equivalent units in the department’s ending
(weighted-average work in process inventory
method)
FIFO method

A process costing method in which equivalent units and unit costs
relate only to work done during the current period
Operation costing
A hybrid costing system used when products have some common
characteristics and some individual characteristics
Process costing
A costing method used when essentially homogeneous products are
produced on a continuous basis
Processing
An organizational unit where work is performed on a product and
department
where materials, labor, or overhead costs are added to the product
Weighted-average
A process costing method that blends together units and costs from
method
both the current and prior periods

Concepts in Action

6


1. Read and fill in the blanks with the following words: combination, customer profile,
production costs, opportunity, job costing, retail stores, a mass-production, hybrid-costing
system, the conversion cost, customized ,three-step, process costing, digitize
Hybrid Costing for Customized Shoes at Adidas
Adidas has been designing and manufacturing athletic footwear for nearly 90 years.
Although shoemakers have long individually crafted shoes for professional athletes like Reggie
Bush of the New Orleans Saints, Adidas took this concept a step further when it initiated the
mi adidas program. Mi adidas gives customers the (1)

to create shoes to their
exact personal specifications for function, fit, and aesthetics. Mi adidas is available in
(2
around the world, and in special mi adidas “Performance Stores” in cities
such as New York, Chicago, and San Francisco.
The process works as follows: The customer goes to a mi adidas station, where a
salesperson develops an in-depth (3)
, a 3-D computer scanner develops
a scan of the customer’s feet, and the customer selects from among 90 to 100 different styles
and colors for his or her modularly designed shoe. During the (4)
, 30-minute
high-tech process, mi adidas experts take customers through the “mi fit,” “mi performance,”
and “mi design” phases, resulting in a customized shoe (5)
their needs. The
resulting data are transferred to an Adidas plant, where small, multiskilled teams produce the
(6)
shoe. The measuring and fitting process is (7)
, but purchasing
your own specially made shoes costs between $40 and $65 on top of the normal retail price,
depending on the style.
Historically, costs associated with individually customized products have fallen into the
domain of job costing. Adidas, however, uses a (8)
— (9)
for
the material and customizable components that customers choose and (10)
to
account for the conversion costs of production. The cost of making each pair of shoes is
calculated by accumulating all (11)
and dividing by the number of shoes
made. In other words, even though each pair of shoes is different, (12)

of
each pair is assumed to be the same.
The (13)
of customization with certain features of mass production is
called mass customization. It is the consequence of being able to (14)
information
that individual customers indicate is important to them. Various products that companies are
now able to customize within (15)
setting (for example,
personal computers, blue jeans, bicycles) still require job costing of materials and considerable
human intervention. However, as manufacturing systems become flexible, companies are also
using process costing to account for the standardized conversion costs.
____________________________________________________________________________

2. Listen and fill in the blanks
Jones Soda
In a world where soda brands and flavors can be found almost anywhere and often fill
entire aisle supermarkets , John Soda manages (1)
from the competition. This
is partly due to quirky label photos which are submitted by customer as well as their fund yet
eccentric line of soda flavors.
7


Mike Spear “

it’s kind of a modern terms but I would say that Jones is an
(2)
, today we had 1,2 million photos in our gallery,
online photo gallery, so we really let consumers participate in the brand. You know that and

our flavors and colors of our flavors are very unique. There is not a lot of green apples sodas
out there, not a lot of fruits sodas out there”
Fans of Jones Soda are so well fanatic that many create video tributes to their favorite
flavors or feel themselves trying some of the more challenging flavor. There are many
companies today that manufacture sodas, so competition is understandably fears for both
market share and sell space.
(3)
is a cost accounting method that works ideally for the soda
industry or any industry where costs are assigned to (4)
that are
(5)
in a continuous fashion. (6)
on the other
hand is better suited for organizations looking to assign costs to (7)
such as
advertising agencies, motion picture companies and law firms. (8)
between
the two include: both (9)
track three manufacturing (10)
, the
accumulation of the costs of materials, labor and overhead and (11)
is the
same. The (12)
between a job order cost and a process cost system are : the
number of (13)
accounts used, the documents used (14)
costs,
the point at which costs are (15)
and unit cost computations
As a general rule, manufacturing of soda normally consists of two processes: blending

and bottling. As the flow of costs indicates companies can add materials labor and
manufacturing overhead in both departments. When the blending Department finishes its work
, they transfer the (16)
to the bottling department. The bottling
department finishes the goods and then transfers (17)
. Within each
department (18)
is performed on (19)
.
Since Jones Soda uses a wide variety of labels particularly within the my Jones personal
customization program, they have three major processes: blending, bottling and labeling. The
use of custom labels has a bit of a story history of Jones Soda .When they first incorporated
custom labels ten years ago, the process was quite humble. They used an intern and inkjet
printer
Mike Spear:” Literally it was sort of a (20)
as business grew we
decided that we had to outsource it and then the process actually goes through a machine
now where the labels are glued in, the liquid goes through a process of applying to the bottles
so it’s not hands on anymore
Vendors such as this can give Jones a (21)
because as suppliers
they have expertise in specialized areas. Alternatively, large (22)
like
Coke and Pepsi have the resources and economy of scale to do almost everything internally.
Now let’s look at an example where we’ve generalized to the assignment of cost at
Jones for the previous month. For purposes of this exercise let’s assume Jones does everything
in-house, so there would be three processes. First ,we have a work - in process for raw
materials. Raw materials used were blending 16,000; bottling 3,000 and labeling 7,000 .
Factory labor costs were blending 10,000; bottling 4,000 and labeling 6,000 and
manufacturing overhead costs were blending 5,000; bottling 2,000 and labeling 2500. The

company transfers units completed at a cost of $19,000 in the blending department to the
bottling department . The bottling department transfers units completed at a cost of $10,000 to
8


the labeling department and the labeling department transfers units completed at a cost of
$8,000 to finished goods .
Companies often use a combination of a process cost and a job order cost system
called (23)
. This (24)
is similar to process costing in
its assumption that (25)
are used to manufacture the product. The my
Jones program for example with its highly customized small quantity order is a good example
of a manufactured product more suited to a job order cost system.
Jones Soda has a model run with the little guy create some changes. Cost accounting
helps Jones to compete in a cutthroat business against industry mega corporations along the
way they’ve inspired a great loyalty among fans and organizations including NASA who
ordered soda during their space shuttle program.
Mike Spear: ” and I find out that was just neat. They put it in their VIP areas so I would
imagine senators and vice president senior drinking Jones as they watch the space shuttle
launched into space. I think in a model of some other soda brands if another CBG brand that
we make this emotional connection with consumers, and it just makes me feel good that we can
make people feel good so”

Summary
Read and fill in the blanks with the following words: transferred out, the cost reconciliation report,
percentage of completion, equivalent units, process costing, a job-order costing system, specific
cost category, partially completed units, costs flow, completed units, weighted-average method ,
work–in process

(1)
is used in situations where homogeneous products or services are
produced on a continuous basis. (2)
through the manufacturing accounts in
basically the same way in a process costing system as in (3)
.
However, costs are accumulated by department rather than by job in process costing..
In process costing, the (4)
of production must be determined for each
cost category in each department. Under the (5)
, the equivalent
units of production equals the number of units transferred out to the next department or to
finished goods plus the equivalent units in ending work in process inventory. The
equivalent
units
in
ending
inventory equals the product of the number of
(6)
in ending work in process inventory and their (7) with respect to
the specific cost category.
Under the weighted-average method, the cost per equivalent unit for a (8)
is
computed by adding the cost of beginning work in process inventory and the cost added during
the period and then dividing the result by the equivalent units of production. The cost per
equivalent unit is then used to value the ending (9)
inventory and the units
(10)
to the next department or to finished goods.
(11)

reconciles the cost of beginning inventory and the costs
added to production during the period to the cost of ending inventory and the cost of units
transferred out. Costs are transferred from one department to the next until the last processing
department. At that point, the cost of (12)
is transferred to finished goods.
9


Questions
1. Under what conditions would it be appropriate to use a process costing system?
2. In what ways are job-order and process costing similar?
3. Why is cost accumulation simpler in a process costing system than it is in a job-order
costing system?
4. How many Work in Process accounts are maintained in a company that uses process
costing?
5. Assume that a company has two processing departments—Mixing followed by Firing.
Prepare a journal entry to show a transfer of work in process from the Mixing Department
to the Firing Department.
6. Assume that a company has two processing departments—Mixing followed by Firing.
Explain what costs might be added to the Firing Department’s Work in Process account
during a period.
7. What is meant by the term equivalent units of production when the weighted-average
method is used?
8. Watkins Trophies, Inc., produces thousands of medallions made of bronze, silver, and
gold. The medallions are identical except for the materials used in their manufacture. What
costing system would you advise the company to use?

Topic 3. CVP analysis
Glossary
No

1
2

Terms
Meaning
Break-even point
The level of sales at which profit is zero
Contribution margin ratio A ratio computed by dividing contribution margin by
(CM ratio)
dollar sales

3

Cost-volume-profit
graph

4

5
6
7
8

(CVP) A graphical representation of the relationships
between
an organization’s revenues, costs, and
profits on the one hand and its sales volume on the
other hand
Degree
of

operating A measure, at a given level of sales, of how a
leverage
percentage change in sales will affect profits. The
degree of operating leverage is computed by dividing
contribution margin by net operating income
Incremental analysis
An analytical approach that focuses only on those
costs and revenues that change as a result of a decision
Margin of safety
The excess of budgeted or actual dollar sales over the
break-even dollar sales
Operating leverage
A measure of how sensitive net operating income is to
a given percentage change in dollar sales
Sales mix
The relative proportions in which a company’s
products are sold. Sales mix is computed by
10


9

Target profit analysis

10

Variable expense ratio

expressing the sales of each product as a percentage of
total sales.

Estimating what sales volume is needed to achieve a
specific target profit.
A ratio computed by dividing variable expenses by
dollar sales

Concepts in action
1. Read and fill in the blanks with the following words: low, competitive disadvantage,
in contrast, loyal listeners, fixed costs, cost structure , revenue, bankruptcy, the weight of,
lost, variable costs decrease, high operating leverage, profitability, in debt, opposite, cut,
high , renegotiating, fee
Fixed Costs, Variable Costs, and the Future of Radio
Building up too much (1)
can be hazardous to a company’s health.
Because fixed costs, unlike (2)
, do not automatically (3)
as
volume declines, companies with too much fixed costs can lose a considerable amount of
money during lean times. Sirius XM, the satellite radio broadcaster, learned this lesson the
hard way.
To begin broadcasting in 2001, both Sirius Satellite Radio and
XM Satellite Radio—the two companies now comprising Sirius XM—spent billions of dollars
on broadcasting licenses, space satellites, and other technology infrastructure. Once
operational, the companies also spent billions on other fixed items such as programming and
content (including Howard Stern and Major League Baseball), satellite transmission, and
R&D. (4)
, variable costs were minimal, consisting mainly of artist-royalty
fees and customer service and billing. In effect, this created a business model with a
(5)
—that is, the companies’ (6)
had a very

significant proportion of fixed costs. As such, (7)
could only be
achieved by amassing millions of paid subscribers and selling advertising.
The (8)
of this highly-leveraged business model was nearly
disastrous. Despite amassing more than 14 million subscribers, over the years Sirius and XM
rang up $3 billion (9)
and tallied cumulative operating losses in excess of $10 billion.
Operating leverage, and the threat of bankruptcy, forced the merger of Sirius
and XM in
2007, and since then the combined entity has struggled to (10)
costs, refinance its
sizable debt, and reap the profits from over 18 million monthly subscribers.
While satellite radio has struggled under (11)
too much fixed cost,
Internet radio had the (12)
problem—too much variable costs. But “How?”
you ask. Don’t variable costs only increase as revenues increase?
Yes, but if the revenue earned is less than the variable cost, an increase in revenue can lead
to (13)
This is almost what happened to Pandora, the Internet radio
service.
Pandora launched in 2005 with only $9.3 million in venture capital. Available free over
the Internet, Pandora earned revenue in three ways: advertising on its Web site, subscription
11


fees from users who wanted to opt-out of advertising, and affiliate fees from iTunes and
Amazon.com. Pandora had (14)
fixed costs but (15)

variable costs for
streaming and performance royalties. Over time, as Pandora’s popular service attracted
millions of (16)
, its costs for performance royalties––set by the Copyright
Royalty Board on a per song basis––far exceeded its revenues from advertising and
subscriptions. As a result, even though royalty rates were only a fraction of a cent, Pandora
(17)
more and more money each time it played another song!
In 2009, Pandora avoided bankruptcy by (18)
a lower per-song
royalty rate in exchange for at least 25% of its U.S. revenue annually. Further, Pandora began
charging its most frequent users a small (19)
and also started increasing its
advertising (20)__________________
__________________________________________________________________________________
2. Listen and fill in the blanks

Southwest Airlines
Brad Hawkins:” Southwest Airlines is simply the most legendary and successful
company in modern aviation history. Almost everyone has a Southwest story whether you are
an employee working for the company or you are a devoted customer to the product the
Southwest offered for nearly 40 years”
Back then in 1971 southwest was just a scrappy upstart with a cheeky sense of humor.
Today they ‘re still cheeky but they carry more passengers within the US than any other
airlines and they’ve been (1)
every single year of their existence even during
(2)
when some competitors were losing 10 to 15 million a day.
Managing any business requires an understanding of how costs respond to changes in
(3

and the effective changes in (4)
in (5)
on (6)
.
Within (7)
companies classify costs in a (8)
of ways.
(9)
are costs that vary in total (10)
with changes
in the (11)
. so for example if an airline paid 10cents a bag for peanuts and a
flight had one passenger the cost for peanuts would be 10cents. If there were 50 passengers the
cost would be $5 and if there were 100 passengers it would be $10. Variables costs may also
be defined as costs that (12)
at every level of activity within
(13)
. So the per unit cost up a bag of peanut would be the same
regardless of the number of passengers on the plane. (14)
are cost that
(15)
regardless of changes in the activity level. the salary of the
pilot on that flight for example would be the same regardless if he or she flew 50 passengers or
100. Because total fixed costs (16)
as (17)
, fixed
costs per unit is very (18)
with activity, as volume increases unit costs decrease
and (19)
. Thus if we were to calculate the pilot salary per passenger for one

passenger the fixed cost per unit would be $200, for 2 passengers it would be $100 and for
100 passengers it would be just $2.
Today airlines like Southwest are thought of largely as variable cost companies
because fuel often their largest cost can (20)
in price. how significant is
this particular variable cost to their (21)
, they consume 1,4 billion gallons
of fuel a year so just a 1 cent per gallon increase equals $14 million. it follows then that
(22)
would play a key role in their (23)
.
12


The most significant relationship in cost volume profit analysis
is the
(24)
at which total revenues equal total costs or the (25)
.
A great way for a company to determine a break – even point is to prepare
(26
also known not surprisingly as (27)
.
Let’s examine a typically airline round trip flight. to keep things simple, we assume that
every ticket costs $100 and that the plane has 150 seats. Okay, looking at our graph we’ve got
the unit of sales along the (28)
which in this case is seats.
The
(29)
is labeled $ because we will use it to record both total revenues and

total costs (fixed plus variable). First, we plot our total sales line starting at zero going up to
(30)
. So total revenue for a full plane would be $100 x 150 seats or $1500.
The revenue line here is (31)
throughout, sets all tickets cost the same.
Next, we plot our total fixed cost which in this case happens to be $4000 and it is the
same at every level of activity. This represents things like the pilot salary overhead in
(32)
. A total cost line starts at the fixed cost line at zero activity. For
this flight we assume a variable cost of $ 60 per seat so if the plane were
(33)
the variable cost would be$60 x 150 seats or $9,000 and the
total cost would be $9,000 in variable costs plus $4,000 in fixed costs or $13,000.
(34)
that total costs from total revenue we get a $2,000 profit round – trip and
where do they break-even? that would be here, at the (35)
of the total cost
line and the total sales line where at 100 seats or $10,000 in sales. Southwest covers the costs
but has not yet earn a profit.
Okay, now the interesting part, Southwest flights are not always full, of course , in fact
the average last year was 75% occupancy. On our graph, that translates to just $480 in profit
round-trip or $240 each way. $240 in profit cannot be true. well yes in fact the
(36)
for a one-way flight on Southwest last year was just slightly
higher at $290 and if your divide that by the average one-way ticket price of $58 you can see
that just 5 passengers per flight kept the most successful airline in the USA
Why are airline margin so razor thin mostly because ticket prices adjusted for inflation
or half of what they were 25 years ago. Fuel costs have (37)
and that explains
why most airlines now charge for checked baggage, most but not Southwest

Brad Hawkins :” the leadership really made a courageous decision. early on this
process the wall street analysts saying “what are you doing ? you’ve leaving hundreds of
millions of dollars in (38)
on the table” but people don’t
want feel nickel-and-dime they don’t want to come back to that”
How did Southwest make this decision by analyzing (39)
and
(40)
. Southwest flights’ re just one type of aircraft and the
resulting efficiencies give them the lowest baggage handling costs in the industry. crunching
the numbers they predicted that the bags fly free program would lead to higher occupancy
rates and more revenue and the profits would outweigh incremental revenue gain from
baggage fees and as Brad’s explain, their prediction was correct.
Brad Hawkins :” our leadership noted a significant share shift more than a 1% which is
about a billion dollars’ worth of customer business shifting over to us for no reason other the
bags fly free strategy”

13


The airline business is complex in few companies today seem to properly manage all
their fixed and variable costs from personnel to fuel contracts to flight schedules. Southwest
does it well, manages customer loyalty and seems to have an awful lot of fun in the process
____________________________________________________________________________
3. Listen and fill in the blanks

Whole foods
Michael Besancon has worked for Whole Foods for most of his adult life. He loves his
job and that has a lot to do with the fact that he feels good about the Whole foods mission.
Michael Besancon:” the number one (1)

of Whole Foods market is to
sell the highest quality natural organic foods possible. Every store of Whole Foods market is
different and every store has a feel. You could blindfold me and take me into a Whole Foods
Market anywhere in the country and I would know I was in a Whole Foods. If I didn’t see any
signs because I would know it by the feel”
Whole Foods sells mostly organic groceries with an emphasis on fresh produces. Their
commitment to sustainable agriculture collaboration with suppliers in community wellness
makes them a premium brand that costs a little more than their big box competitors but
maintaining high quality and great value for the customers without compromising their core
values is the true secret to their success.
(2)

(CVP) is the study of the effects of changes in
(3)
and (4)
on the (5)
. Is it important to (6)
?
determining (7)
? Maximizing use of (8)
?
setting (9)
? and often reported in a (10)
for
(11)
. The income statement classifies costs as variable or fixed and compute
a (12)
- the amount of revenue remaining after deducting variable
costs.
Let’s start by reviewing some basics about CVP analysis, specifically break-even

analysis, target net income and margin of safety. For sake of simplicity, let’s assume you’re
selling just one product tomatoes at a farmers market. (13)
can be
computed by taking fixed costs
and dividing by the contribution margin
((14)
). Contribution margin can also be expressed in the form of
the (15)
, contribution margin divided by sales providing the
break-even point in dollars versus units. When a company is in its early stages of operation, the
(16)
is break even. Failure to do so will lead to (17)
.
Once you’ve determined the break-even point, you want to set a sale goal that will
generate a (18)
. This will provide you with (19
in
either units or dollars depending on whether you use a contribution margin per unit or
contribution margin ratio. Finally, (20)
indicates how much sales
can decline before you’re operating at a loss and again can be expressed in dollar terms or as a
percentage
Ok, that seems easy enough. Now let’s get back to the Whole foods where things are
slightly more complicated because Whole Foods doesn’t just sell tomatoes, they sell thousands
of different products with different costs that fluctuate constantly under a variety of
(21)
such as the weather, competition and transportation costs.
14

Michael Besancon:” Produce could be a higher because of lower freight costs in one
area and in another area it could have a lower margin on it. what you have to do is you have to
blend your margin across the full spectrum of products “
Whole foods starts by determining their (22)
, the (23)
in
which they sell their (24)
. Sales mix is important to managers because different
products often have substantially different contribution margin. Managers can compute breakeven sales for a mix of two or more products by determining the (25)
unit
contribution margin of all the products. However to avoid having to calculate thousands of
different unique contribution margins they calculate the break-even point in terms of sales
dollars rather than units sold. Using sales information for division of product lines, also they
must compute the (26)
rather than contribution margin per unit.
Ultimately, information such as this provided using CVP analysis can help managers better
understand the impact of sales mix on (27)
.
Price fluctuation is one thing but what happens when fluctuation strikes whole nations
and industries. during the recent recession, Whole Foods managed to actually maintain
profitability despite opening 16 new stores, they did this by reducing certain premium prices
and reducing the size of each new store allowing for savings in other areas
Michael Besacon “and we have moved into a direction of what we call right – sizing
stores and the savings from that is that the rent obvious utilities and fewer team members
would be needed to start a store”
Companies that have higher fixed costs relative to variable costs have higher
(28)
. Operating leverage is calculated as the contribution margin
divided by the (29)
. When a company sales revenues are increasing high

operating leverage can mean that profits will increase rapidly. However when sales are
declining too much operating leverage can have quite devastating effects on the company. By
working with suppliers and streamlining store space to control costs lower overhead gives
Whole Foods a way to lower operating leverage. This coupled with an increased
(30)
or during trouble times allows Whole Foods to continue as a
competitive alternative for health-conscious grocery shoppers

Summary
Read and fill in the blanks with the following words: the contribution margin ratio,
special case, sales mix, CVP analysis, a CVP graph, net operating income, break-even
analysis, critical questions, fixed expense, exceeds, the degree of operating leverage, constant,
multiproduct, the margin of safety, specified target profit
(1)
is based on a simple model of how profits respond to prices,
costs, and volume. This model can be used to answer a variety of (2)
such
as what is the company’s breakeven volume, what is its margin of safety, and what is likely to
happen if specific changes are made in prices, costs, and volume.
(3)
depicts the relationships between unit sales on the one hand and
fixed expenses, variable expenses, total expenses, total sales, and profits on the other hand. The
profit graph is simpler than the CVP graph and shows how profits depend on sales. The CVP
15


and profit graphs are useful for developing intuition about how costs and profits respond to
changes in sales.
(4)
is the ratio of the total contribution margin to total sales.

This ratio can be used to quickly estimate what impact a change in total sales would have on
(5)
. The ratio is also useful in (6)
.
Target profit analysis is used to estimate how much sales would have to be to attain a
(7)
. The unit sales required to attain the target profit can be estimated by
dividing the sum of the target profit and (8)
by the unit contribution
margin. Break-even analysis is a (9)
of target profit analysis that is used to
estimate how much sales would have to be to just break even. The unit sales required to break
even can be estimated by dividing the fixed expense by the unit contribution margin.
(10)
is the amount by which the company’s current sales
(11)
break-even sales. (12)
allows
quick estimation of what impact a given percentage change in sales would have on the
company’s net operating income. The higher the degree of operating leverage, the greater is the
impact on the company’s profits. The degree of operating leverage is not (13)
—it
depends on the company’s current level of sales. The profits of a (14)
company
are affected by its (15)
. Changes in the sales mix can affect the break-even point,
margin of safety, and other critical factors.

Questions
1. What is meant by a product’s contribution margin ratio? How is this ratio useful in

planning business operations?
2. Often the most direct route to a business decision is an incremental analysis. What is meant
by an incremental analysis?
3. In all respects, Company A and Company B are identical except that Company A’s costs
are mostly variable, whereas Company B’s costs are mostly fixed. When sales increase,
which company will tend to realize the greatest increase in profits? Explain.
4. What is meant by the term operating leverage?
5. What is meant by the term break-even point?
6. In response to a request from your immediate supervisor, you have prepared a CVP graph
portraying the cost and revenue characteristics of your company’s product and operations.
Explain how the lines on the graph and the break-even point would change if (a ) the
selling price per unit decreased, (b ) fixed cost increased throughout the entire range of
activity portrayed on the graph, and (c) variable cost per unit increased.
7. What is meant by the margin of safety?
8. What is meant by the term sales mix? What assumption is usually made concerning sales
mix in CVP analysis?
9. Explain how a shift in the sales mix could result in both a higher break-even point and a
lower net income.

16


Topic 4. Static Budgets
Glossary
No
1
2

3
4

5

6
7

8

9

10

11

12
13
14
15

16

Terms
Budget

Meaning
A detailed plan for the future that is usually expressed
in formal quantitative terms.
Budget committee
A group of key managers who are responsible for
overall budgeting policy and for coordinating the
preparation of the budget.

Cash budget
A detailed plan showing how cash resources will be
acquired and used over a specific time period.
Continuous budget
A 12-month budget that rolls forward one month as
the current month is completed.
Control
The process of gathering feedback to ensure that a
plan is being properly executed or modified as
circumstances change.
Direct labor budget
A detailed plan that shows the direct labor-hours
required to fulfill the production budget.
Direct materials budget
A detailed plan showing the amount of raw materials
that must be purchased to fulfill the production budget
and to provide for adequate inventories.
Ending finished
goods A budget showing the dollar amount of unsold
inventory budget
finished goods inventory that will appear on the
ending balance sheet.
Manufacturing
overhead A detailed plan showing the production costs, other
budget
than direct materials and direct labor, that will be
incurred over a specified time period.
Master budget
A number of separate but interdependent budgets that
formally lay out the company’s sales, production, and

financial goals and that culminates in a cash budget,
budgeted income statement, and budgeted balance
sheet.
Merchandise
purchases A detailed plan used by a merchandising company that
budget
shows the amount of goods that must be purchased
from suppliers during the period.
Participative budget
See Self-imposed budget.
Perpetual budget
See Continuous budget.
Planning
Developing goals and preparing budgets to achieve
those goals.
Production budget
A detailed plan showing the number of units that must
be produced during a period in order to satisfy both
sales and inventory needs.
Sales budget
A detailed schedule showing expected sales expressed
in both dollars and units.
17


17

18

Self-imposed budget

A method of preparing budgets in which managers
prepare their own budgets. These budgets are then
reviewed by higher-level managers, and any issues are
resolved by mutual agreement.
Selling and administrative A detailed schedule of planned expenses that will be
expense budget
incurred in areas other than manufacturing during a
budget period.

Concepts in action
Read and fill in the blanks with the following words: budgeting, value, companies, control, runs,
accounts, managers, experts, expenses, revenue, sensitivity, competitive, users, decision making
Web-Enabled Budgeting and Hendrick Motorsports
In recent years, an increasing number of (1)
have implemented
comprehensive software packages that manage budgeting and forecasting functions across the
organization. One such option is Microsoft Forecaster, which was originally designed by FRx
Software for businesses looking to gain (2)
over their budgeting and forecasting
process within a fully integrated Web-based environment.
Among the more unique companies implementing Web-enabled budgeting is Hendrick
Motorsports. Featuring champion drivers Jeff Gordon and Jimmie Johnson, Hendrick is the
premier NASCAR Sprint Cup stock car racing organization. According to Forbes magazine,
Hendrick is NASCAR’s most valuable team, with an estimated (3)
of $350 million.
Headquartered on a 12 building, 600,000-square-foot campus near Charlotte, North Carolina,
Hendrick operates four full-time teams in the Sprint Cup series, which (4)
annually
from February through November and features 36 races at 22 speedways across the United

States. The Hendrick organization has annual (5)
of close to $195 million and more
than 500 employees, with tasks ranging from accounting and marketing to engine building and
racecar driving. Such an environment features multiple functional areas and units, varied
worksites, and ever-changing circumstances. Patrick Perkins, director of marketing, noted,
“Racing is a fast business. It’s just as fast off the track as it is on it. With the work that we put
into development of our teams and technologies, and having to respond to change as well as
anticipate change, I like to think of us in this business as change (6)
.”
Microsoft Forecaster, Hendrick’s Web-enabled budgeting package, has allowed
Hendrick’s financial managers to seamlessly manage the planning and budgeting process.
Authorized users from each functional area or team sign on to the application through the
corporate intranet. Security on the system is tight: Access is limited to only the (7)
that
a manager is authorized to budget. (For example, Jeff Gordon’s crew chief is not able to see
what Jimmie Johnson’s team members are doing.) Forecaster also allows (8)
at the
racetrack to access the application remotely, which allows (9)
to receive or update realtime “actuals” from the system. This way, team managers know their allotted (10)
for
each race. Forecaster also provides users with additional features, including seamless links
with general ledger accounts and the option to perform what-if ((11)
) analyses. Scott
Lampe, chief financial officer, said, “Forecaster allows us to change our forecasts to respond to
changes, either rule changes [such as changes in the series’ points system] or technology
18


changes [such as pilot testing NASCAR’s new, safer “Car of Tomorrow”] throughout the
racing season.”

Hendrick’s Web-enabled budgeting system frees the finance department so it can work
on strategy, analysis, and (12)
. It also allows Hendrick to complete its annual
(13)
process in only six weeks, a 50% reduction in the time spent budgeting and
planning, which is critical given NASCAR’s extremely short off-season. Patrick Pearson from
Hendrick Motorsports believes the system gives the organization a (14)
advantage:
“In racing, the team that wins is not only the team with the fastest car, but the team that is the
most disciplined and prepared week in and week out. Forecaster allows us to respond to that
changing landscape.”

Budgetary Planning at BabyCakes
Listen and fill in the blanks
OK. So, you are the owner of BabyCakes NYC, the most popular health-conscious
vegan bakery in the city and you just opened a second store but it’s all the way across country
in Los Angeles, and you’re facing your first big holiday rush, so how you can budget for it?
First, let’s go over some basics. Budgeting which is defined as a written statement that
management’s plans for a specific period expressed in (1)
is a cornerstone of
planning for any business, large or small.
Erin McKenna: “Aside from doing the baking, the frosting and designing uniforms, I’m
also in charge of all (2)
myself. Budgeting definitely makes us more
efficient and helps us judge (3)
of the company and it help us be a little bit
more responsible in (4)
.”
Once budgets are established, they become important basis for evaluating future
performance. They can motivate (5)

to meet objectives, they serve as a
deterrent waste, to promote efficiency and they can serve as (6)
.
Erin McKenna: ‘If I didn’t budget I would definitely overspent because there’s so many
things that I want to do for the bakery. It’s like having a baby, and you want to dress it up, and
you want to take it to Disney World, and you want to make it as fun as possible.”
Sometimes people confuse budgeting with planning. Whereas planning focuses on
(7)
, budgeting deals with (8)
Budgets can be
prepared for any period of time. In the case of Babycakes, Erin prepares (9)
budget
which is supplemented by (10)
budgets.
Erin McKenna: “From there we know what we can buy, how much we put into certain
items and that way we can look at an extended period of sales trends or weather, holidays...”
Holidays like Valentine’s Day which brings us back to our starting point. With
Valentine’s Day quickly approaching Erin’s need to be sure that she has allocated
(11)
to handle the rush, assuming there will be a rush in the new
location. So how did she proceed?
In business, (12)
normally contains two classes of budgets.
(13)
, which will discuss in this video, and (14)
. There
are many different types of (15)
but we’ll focus on the two that Erin uses
predominately. Budget goals of course are based on past performance. In larger companies,
data collected from various organizational units beginning several months before the end of

19


current year. Because it is derived from (16)
, every other budget depends on it,
the sales budget is the first budget prepared. Normally companies forecast sales by considering
a variety of factors but Erin doesn’t always have all these at her disposal on the new LA
bakery.
Erin McKenna: “It can be challenging to plan for Valentine’s Day because we don’t
have past years that we’ve been at this location.”
In the absence of (17)
she’ll refer to data from her New York store for
guidance. One thing she learned over the year is that Valentine’s Day is not a holiday to be
taken lightly.
Erin McKenna: “Our first Valentine’s Day in New York we baked a little bit more than
usual, but right when we open our door, there is a line, you know, sneaking around the block
and we couldn’t take fast enough. So I leant my lesson very quickly that time.”
In terms of marketing, Erin keeps her holiday costs low in the new location by using
her creativity and by making use of online social network.
Erin McKenna: “We will tweet that we have special sweetheart boxes, two cupcakes
and window box and it looks like a little present. And things like heart shaped cookies and that
would usually get the word out enough for us. ”
Because Babycakes appeals to a very specific demographic, people with food allergies
Erin can’t really look to changes like Sprinkles for industry trends. As a general rule, Erin
tends to over-bake rather than under-bake so as not to disappoint our customers. In the end she
doesn’t move all of her product, she can always sell items the following day at
(18)___________________
The bottom line is that for small businesses (19)
can be
somewhat informal at times. Erin takes a very hands-on approach to her business which allows

her to spot trends, minimize waste and trust her instincts.
Erin McKenna: “When I’m here and I see the waste then the ideas come. And when I
see their reactions to certain items, the doughnuts, brings a really big emotional reaction from
people. And if I didn’t see that then I wouldn’t know to put more money into doughnut pans
and I will, for example, say, the corn bread isn’t selling, stop making it. You know, like as you
see all the little details.”
OK. Now let’s look at an example in her LA store, let’s say that Erin normally sell
about 1,000 up the red velvet cupcakes a day at $3.5 each. On a Valentine’s Day she expects to
sell an additional 500 or 1,500 red velvet cupcakes in total. So we multiply (20)
by
(21)
to obtain total sales which in this case is 5,250 for the red velvet
cupcakes. So she knows that she needs to ensure she has enough supplies to handle the
production. Next, let’s look at the production budget which shows the units must be produced
to meet the anticipated sales. This is derived from the sales budget plus the desired change in
(22)
. In an ideal world, a bakery wants to end the day by selling all
of its product. However, it needs to maintain supplies to produce the next day’s product. The
required production in units formula is: budgeted sales units plus desire ending finished goods
units minus (23)
equals required production units. So, if
they sell 1,000 red velvet cupcakes each day on average and I have to account for an extra 500
red velvet cupcakes on Valentine’s Day, there are only enough raw materials for the holiday
but for the days that follow. This is obviously a very simplified example but you can imagine it
20


gets even more complicated when Erin has to take into account different types of cupcakes and
other products and flavors.
Erin worked hard to budget for Valentine’s Day in her new location despite not having

much history to help guide her decisions. She relied on a combination of
(24)
and informal budgeting intuition to help her make
decisions and the results or lack of them speak for themselves.
Erin McKenna: “Looks like it’s a big success! Budgeted perfectly.”
She did extremely well in her playing with respect to cupcakes running out just before closing
time. and best of all she knows that she has enough supplies for tomorrow with the entire
process starts all over again at 4 a.m.

Summary
Read and fill in the blanks with the following words: budget, budgeting, budgeted,
production, produce, manufacturing, sold, relate, master, cash
This chapter describes the (1)
process and shows how the various operating
budgets (2)
to each other. The sales (3)
is the foundation for profit
planning. Once the sales budget has been set, the (4)
budget and the selling and
administrative expense budget can be prepared because they depend on how many units are to
be (5)
. The production budget determines how many units are to be (6)
,
so after it is prepared, the various (7)
cost budgets can be prepared. All
of these budgets feed into the (8)
budget and the budgeted income statement and
balance sheet. The parts of the (9)
budget are connected in many ways. For
example, the schedule of expected cash collections, which is completed in connection with the

sales budget, provides data for both the cash budget and the (10)
balance sheet.

Questions
1.
2.
3.
4.
5.
6.
7.
8.
9.

What is a budget? What is budgetary control?
Discuss some of the major benefits to be gained from budgeting.
What is a master budget? Briefly describe its contents.
Why is the sales forecast the starting point in budgeting?
“As a practical matter, planning and control mean exactly the same thing.” Do you agree?
Explain.
Describe the flow of budget data in an organization. Who are the participants in the
budgeting process, and how do they participate?
What is a self-imposed budget? What are the major advantages of self-imposed budgets?
What caution must be exercised in their use?
How can budgeting assist a company in planning its workforce staffing levels?
“The principal purpose of the cash budget is to see how much cash the company will have
in the bank at the end of the year.” Do you agree? Explain.

21

Topic 5. Flexible Budgets
Glossary
No
1

Terms
Activity variance

2

Flexible budget

3
4

Ideal standards
Labor efficiency variance

5

Labor rate variance

6

Management by exception

7

Materials price variance

8

Materials quantity variance

9

Planning budget

10

Practical standards

11

Price variance

Meaning
The difference between a revenue or cost item in the
static planning budget and the same item in the
flexible budget. An activity variance is due solely to
the difference between the level of activity assumed in
the planning budget and the actual level of activity
used in the flexible budget.
A report showing estimates of what revenues and costs
should have been, given the actual level of activity for
the period.
Standards that assume peak efficiency at all times.
The difference between the actual hours taken to
complete a task and the standard hours allowed for the

actual output, multiplied by the standard hourly labor
rate.
The difference between the actual hourly labor rate
and the standard rate, multiplied by the number of
hours worked during the period.
A management system in which standards are set for
various activities, with actual results compared to
these standards. Significant deviations from standards
are flagged as exceptions.
The difference between the actual unit price paid for
an item and the standard price, multiplied by the
quantity purchased.
The difference between the actual quantity of
materials used in production and the standard quantity
allowed for the actual output, multiplied by the
standard price per unit of materials.
A budget created at the beginning of the budgeting
period that is valid only for the planned level of
activity.
Standards that allow for normal machine downtime
and other work interruptions and that can be attained
through reasonable, though highly efficient, efforts by
the average worker.
A variance that is computed by taking the difference
between the actual price and the standard price and
multiplying the result by the actual quantity of the
22


12

Quantity variance

13

Revenue variance

14

Spending variance

15

Standard cost card

16

Standard cost per unit

17

Standard hours allowed

18

Standard hours per unit

19
20

Standard price per unit
Standard quantity allowed

21

Standard quantity per unit

22

Standard rate per hour

input.
A variance that is computed by taking the difference
between the actual quantity of the input used and the
amount of the input that should have been used for the
actual level of output and multiplying the result by the
standard price of the input.
The difference between how much the revenue should
have been, given the actual level of activity, and the
actual revenue for the period. A favorable
(unfavorable) revenue variance occurs because the
revenue is higher (lower) than expected, given the
actual level of activity for the period.
The difference between how much a cost should have
been, given the actual level of activity, and the actual
amount of the cost. A favorable (unfavorable)
spending variance occurs because the cost is lower
(higher) than expected, given the actual level of
activity for the period.
A detailed listing of the standard amounts of inputs

and their costs that are required to produce one unit of
a specific product.
The standard quantity allowed of an input per unit of a
specific product, multiplied by the standard price of
the input.
The time that should have been taken to complete the
period’s output. It is computed by multiplying the
actual number of units produced by the standard hours
per unit.
The amount of direct labor time that should be
required to complete a single unit of product,
including allowances for breaks, machine downtime,
cleanup, rejects, and other normal inefficiencies.
The price that should be paid for an input.
The amount of an input that should have been used to
complete the period’s actual output. It is computed by
multiplying the actual number of units produced by
the standard quantity per unit.
The amount of an input that should be required to
complete a single unit of product, including
allowances for normal waste, spoilage, rejects, and
other normal inefficiencies.
The labor rate that should be incurred per hour of
labor time, including employment taxes and fringe
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benefits.
Variable
overhead The difference between the actual level of activity
efficiency variance
(direct labor-hours, machine-hours, or some other
base) and the standard activity allowed, multiplied
by the variable part of the predetermined overhead
rate.
Variable overhead rate The difference between the actual variable overhead
variance
cost incurred during a period and the standard cost that
should have been incurred based on the actual activity
of the period.

Concepts in action
Read and fill in the blanks with the following words: direct, labor, materials, waste, spoilage,
increase, reducing, expenses, costs, revenue, profit. variances, analysis.
Starbucks Reduces Direct-cost Variances to Brew a Turnaround
Along with coffee, Starbucks brewed profitable growth for many years. From Seattle
to Singapore, customers lined up to buy $4 lattes and Frappuccinos. Walking around with a
coffee drink from Starbucks became an affordable-luxury status symbol. But when consumers
tightened their purse strings amid the recession, the company was in serious trouble. With
customers cutting back and lower-priced competition—from Dunkin’ Donuts and McDonald’s
among others—increasing, Starbucks’ (1)
margins were under attack.
For Starbucks, profitability depends on making each high-quality beverage at the
lowest possible (2)
. As a result, an intricate understanding of direct costs is critical.
Variance (3)

helps managers assess and maintain profitability at desired levels. In
each Starbucks store, the two key (4)
costs are materials and labor.
(5)
costs at Starbucks include coffee beans, milk, flavoring syrups,
pastries, paper cups, and lids. To reduce budgeted costs for materials, Starbucks focused on
two key inputs: coffee and milk. For coffee, Starbucks sought to avoid waste and (6)
by
no longer brewing decaffeinated and darker coffee blends in the afternoon and evening, when
store traffic is slower. Instead, baristas were instructed to brew a pot only when a customer
ordered it. With milk prices rising (and making up around 10% of Starbucks’ cost of sales), the
company switched to 2% milk, which is healthier and costs less, and redoubled efforts to
reduce milk-related spoilage.
Labor costs at Starbucks, which cost 24% of company (7)
annually, were
another area of variance focus. Many stores employed fewer baristas. In other stores, Starbucks
adopted many “lean” production techniques. With 30% of baristas’ time involved in walking
around behind the counter, reaching for items, and blending drinks, Starbucks sought to make
its drink-making processes more efficient. While the changes seem small—keeping bins of
coffee beans on top of the counter so baristas don’t have to bend over, moving bottles of
flavored syrups closer to where drinks are made, and using colored tape to quickly differentiate
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between pitchers of soy, nonfat, and low-fat milk—some stores experienced a 10%
(8)
in transactions using the same number of workers or fewer.
The company took additional steps to align (9)
costs with its pricing.
Starbucks cut prices on easier-to-make drinks like drip coffee, while lifting prices by as much

as 30 cents for larger and more complex drinks, such as a venti caramel macchiato.
Starbucks’ focus on (10)
year-over-year variances paid off. In fiscal year
2009, the company reduced its store operating (11)
by $320 million, or 8.5%.
Continued focus on direct-cost (12)
will be critical to the company’s future
success in any economic climate.

Summary
Summary 1
Read and fill in the blanks with the following words: favorable, unfavorable, flexible, static,
actual, budgeted, reasons, spending, level, cost, fixed, variable, variances, behavior, activity,
change, compared, adjusted
Directly comparing (1)
planning budget revenues and costs to (2)
revenues
and costs can easily lead to erroneous conclusions. Actual revenues and costs differ from
budgeted revenues and costs for a variety of (3)
, but one of the biggest is a (4)
in
the level of activity. One would expect actual revenues and costs to increase or decrease as the
activity level increases or decreases. (5)
budgets enable managers to isolate the
various causes of the differences between budgeted and actual costs.
A flexible budget is a budget that is (6)
to the actual level of activity. It is the
best estimate of what revenues and costs should have been, given the actual level of activity
during the period. The flexible budget can be (7)
to the budget from the beginning

of the period or to the actual results.
When the flexible budget is compared to the budget from the beginning of the period,
(8)
variances are the result. An activity variance shows how a revenue or cost should
have changed in response to the difference between (9)
and actual activity.
When the flexible budget is compared to actual results, revenue and (10)
variances
are the result. A (11)
revenue variance indicates that revenue was larger than
should have been expected, given the actual level of activity. An (12)
revenue
variance indicates that revenue was less than it should have been, given the actual level of
activity. A favorable spending variance indicates that the cost was less than expected, given the
actual (13)___________
of activity. An unfavorable spending variance indicates that the
(14)
was greater than it should have been, given the actual level of activity.
A flexible budget performance report combines the activity variances and the revenue
and spending variances on one report.
Common errors in comparing budgeted costs to actual costs are to assume all costs are
(15)
or to assume all costs are (16)
. If all costs are assumed to be fixed,
the (17)
for variable and mixed costs will be incorrect. If all costs are assumed to be
variable, the variances for fixed and mixed costs will be incorrect. The variance for a cost will
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