Essay Part 1

2020 -
Essay Question and

2021
Answer Book
CMA US (Part – I)
Complied By: Prof. Ravi Gupta
Section B - Planning, Budgeting and Forecasting
Case -1
Marval Products manufactures and wholesales several different lines of luggage in two basic types—soft side and
molded. Each luggage line consists of several different pieces, all of which are in different sizes. At least one line is a
complete set of luggage designed to be used by both men and women, but some lines and styles are designed
specifically for men or women. Some lines also have matching briefcases. Luggage lines are discontinued and introduced
as tastes change or as product improvements are developed.
Marval Products also manufactures luggage for large retail companies according to each company’s specifications. This
luggage is marketed under the retail companies own private labels rather than the Marval label. Marval has been
manufacturing several lines of luggage under its own label and private lines for one or more retail companies for the
last ten years.
1. Identify and discuss the factors Marval Products needs to consider in its periodic review of long-term
product strategy including any decisions with respect to new and/or existing products.
2. Identify and discuss the factors Marval Products needs to consider when developing its sales component of
the annual budget.
Answer:
1. Specific factor that Marvel products need to consider in its periodic review of long-term product strategy
include the following:
• Examine current state of the economy and its expected future status, and the current and future
availability of resources such as manpower, plant and equipment, and capital,
• Review of consumer attitudes with regards to products appeal, changing travel modes and
pattern, and changing life styles and affluence.
• Analyze the level of industry sales, Marvel’s current and projected market shares, and Marvel’s
degree of influence or dominance in the industry.
• Examine the product lines with respect to the nature of the production process length of time of
the project has been established, and utilization of resources and plant capacity.
2. Factors that marvel products needs to consider when developing the sales component of its annual
budget include the pricing strategy, size of Marvel’s market share and the relationship to its competitors,
sale mix of products such that contribution can be maximized, available production capacity, effect of
advertising on sale volume, and national and international economic condition.
1|CMA US (Part I) Complied By: Prof. Ravi Gupta

Case - 2
Stark Manufacturing, a division of Davis Corporation, produces and sells a variety of leather goods to both wholesalers
and retail outlets. Four months ago, Davis sent a team from their Internal Audit Department to Stark to perform a
routine review of operations. A portion of the audit report presented to Davis on the operations of Stark is presented
below.
Observation
Departmental budgets are not being utilized at Stark. Currently, the division does not have the automated systems
capability to produce budget analyses at the departmental level. Traditional-ly, the plant has been controlled through
a total plant concept rather than a departmental approach to cost control. Given present business conditions, this
approach may no longer be the optimum control process. Increased competition in the marketplace, declining profits,
deteriorating margins, and in-creased costs have combined to necessitate an aggressive approach to cost reduction.
Based on experience at other Davis plants, we believe that Stark would benefit from the development and use of
departmental budgets for all functions.
Recommendation
We recommend that Stark establish a management objective to develop and utilize flexible departmental expense
budgets for all departments. Resources and systems development efforts should be devoted to this objective as they
become available. We suggest, as an interim step, that operating budgets be employed on a monthly basis. Operating
targets for both direct labor and indirect labor expense should be established for each manufacturing department
monthly. Departmental managers should track performance and explain deviations from targets as part of the regular
agenda at the weekly production meetings.
Preliminary Management Response

Stark will develop and utilize a flexible departmental budget system. In the interim, work has begun to establish daily,
month-to-date, and annual targets for direct and indirect labor for the manufacturing departments. These targets
include efficiency objectives, overtime objectives, and indirect labor usage objectives based on volume and product
mix.
Prior to making the Preliminary Management Response presented in the audit report, the president of Stark
announced to the departmental managers that the company was planning to accept the audit recommendation
implement a departmental budgeting system. The managers were asked for suggestions on implementation
procedures and were encouraged to raise any questions they might have about the budget system.
1. Describe the benefits, other than better cost control, that are likely to accrue to Stark Manufacturing from
the implementation of departmental budgeting.
2. Discuss the behavioral impact the introduction of departmental budgeting is likely to have on Stark
Manufacturing's
I. departmental managers.
II. production workers.
2|Essay Question and Answer s Sheet

3. Describe several steps that Stark Manufacturing should take in order to gain maximum acceptance of the
new departmental budgeting system.
Answer:
1. Benefits, other than better cost control, that are likely to accrue to stark Manufacturing from the
implementation of departmental budgeting includes
• Improved goal congruence. Because each department will be involved in the planning goals there
by improving the planning process.
• Improved communication and coordination. Because departments are generally interdependent,
the process of planning and preparing departmental budgets will necessitate greater
communication and coordination among departments.
• Easier assignment of responsibility and accountability. As planning becomes more formalized and
goals and duties more definitive, line of responsibility and accountability become clear.
2.
I. The introduction of departmental budgeting may have both positive and negative behavioral
effects on Stark Manufacturing’s departmental managers.
The positive behavioral effects may include.
• Increased motivation to meet company objectives, particularly if they have participated in
establishing these objectives and believe the objectives are attainable.
• Increased acceptance of performance evaluation criteria as they have helped to develop these
criteria and know what is expected of them.
The negative behavioral impacts may include
• The normal level of apprehension and resistance that accompanies most organizational changes.
• Concern that the comparison of actual result to budgeted numbers could have a negative impact
on performance evaluation.
II. If the budgets are accepted by the departmental managers, the production workers may be
motivated to achieve the departmental objectives. If the production workers have been allowed to
participate in the planning process, belie the goals are attainable, and/or believe that the
achievement of goals will result in rewards, the motivation will be greater. If the budget is imposed
or the goals are perceived as unattainable, the reaction of production workers is likely to be
negative.
3. Steps that Stark Manufacturing should take in order to gain maximum acceptance of the new
departmental budgeting system include
• Evidence that the new procedure has top management support.
• Increased communication with all affected employees explaining the reasons for the change.

• Providing avenues for feedback and being responsive to employee questions and suggestions.
• Changing budgetary restrictions when conditions change.
Case 3
Great Rivers International is a global company operating mainly in North America, Europe, and Asia. Two years ago, the
company decided to enter the Africa market through its subsidiary in Africa, Nile River Company. Nile River Company
has just completed building its pharmaceutical plant in Africa. The total project cost was $26.1 million, as shown below.
Building $10.0 million

Machinery and equipment 15.0 million
Furniture and fixtures 0.5 million
Vehicles 0.2 million
Working capital 0.4 million
Total $26.1 million
Next year will be the first year of operation for Nile River Company after almost two years being in a development
stage. The company has formulated its strategic plan and an operational plan for next year. Management intends to
translate the operational plan into a master budget. The finance manager at Nile River Company is responsible for all
planning and budgeting activities in the company. Next year’s master budget will be the first master budget to be
prepared for Nile River Company.
1. Define the master budget and outline the process that should be followed in order to prepare the budget
at Nile River Company.
2. Identify the components of the sales budget. Explain the interrelationships of the sales budget with the
other components of the master budget.
3. Assume that the company is expecting to sell 10,000 units of product during its first year of operation
and that the expected annual sales growth is 5% during the second year of operation. Assume further
that the first year’s desired ending inventory is 30% of the following year’s sales. What will be the
budgeted production quantity during the first year of operation? Show your calculations.
4. Other than sales, identify two other budgets that should be prepared in order to prepare budgeted net
operating income.
5. Identify and explain three characteristics of a successful budgeting process.

Answer:
1. Master budget is an organization’s operating and financing plan for the upcoming period; it translates
short-term objectives into action steps.
The budgeting process usually includes the formation of a budget committee; determination of the budget
period; specification of budget guidelines; preparation of the initial budget proposal; budget negotiation,
review and approval; and budget revision.
2. The sales budget is often regarded as the cornerstone of master budget at any company, and Nile River
Company is not an exception. In budgeting and planning process, sales budget should be completed first.
After preparation of sales budget, the production budget and all the other budget an all the other budgets
for the company are derived from the sales budget. If sales are expected to be low, there will be no need
for much inventory, many sales manpower, and so on. On the other hand, if sales are expected to be high,
there will be more need for these items.
3. The budgeted production quantity can be calculated according to the following formula:
Budgeted production (in units) = Budgeted sales (in units) + Desired ending inventory (in units) –
Beginning inventory (in units)
Budgeted sales (in units) = 10,000

Desired ending inventory (in units) = next year sales (10,000*1.05) multiplied by 30% beginning
inventory (in units) will be zero since it’s the first year of operation
Budgeted production (in units) = 10,000 + 10,000*1.05*30%-0=13,150
4. Other than sales, the other two budgeted that should be prepared in order to prepare budgeted net
operating income before interest expense and income tax are:
• Cost of goods sold budget
• Selling and general administrative expenses budget
5. The success of a budget program may be determined by how the budget is developed.
• In most successful budget programs, department managers participate with upper management
in preparing their own budgets. Department managers are more likely to have close knowledge
of their areas of responsibility and, therefore, budget estimates may be more reliable. When
managers are involved in preparing their budgets, they are more likely to believe their judgements
are valued by top management and are more likely to be committed to meeting the budget.
• The success of a budget program also depends on whether top management believes the budget
program is a vital part of the company’s activities and how top management uses budget
information.

Case - 4
Lasertech is a start-up company that was founded by three college friends Mark, Mike and Stella, right after they
graduated from medical school. They had a vision of utilizing laser technology and selling it to hospitals and physicians
to enable less-invasive surgeries. The company has been struggling in recent years. Sales have fluctuated and the
company is often left with unsold inventory of products. Mark prepares monthly production schedules based on sales
of the previous two months. The production schedule triggers the purchase of inventory. Stella monitors sales and
inventory levels and plans promotions to sell slow-moving inventory. Mike monitors the cash flow and borrows against
a line of credit when cash is low. The company founders brought in a consultant to assist the company in increasing
sales, lowering costs, and controlling inventory. The consultant recommended implementing a formal budgeting
process as the first step in the process of improving performance.
1. Describe the role budgeting plays in strategic planning.

2. Describe the role budgeting plays in defining short-term objectives.
3. Identify and explain three characteristics of a successful budgeting process.
4. Explain how the budgeting process might be able to facilitate communication among the manufacturing,
marketing, and finance units of the company.
5. Define flexible budgeting and explain how it is used.
6. Identify two other types of that companies use other than flexible budgeting.
Answer:
1. Strategic planning involving setting long-term goals extending 30 to 5 years into the future and
preparing long-term budgets that reflect these goals. Planning involves developing objectives for each
function of the company and preparing budgets to meet those objectives. Control involves monitoring
the various functions to assure that objectives are attained.
2. Once the long-term goals and strategies are developed, management can focus on a short-term goal to
assist in planning and controlling the production, marketing and financial functions of the company.
3. The success of a budget program may be determined by how the budget is developed.
• In most successful budget programs, department managers participate with upper management
in preparing their own budgets. Department managers are more likely to have close knowledge
of their areas of responsibility and, therefore, budget estimates may be more reliable. When
managers are involved in preparing their budgets, they are more likely to believe their
judgments are valued by top management and are more likely to be committed to meeting the
budget.
• The success of a budget program also depends on whether top management believes the
budget program is vital part of the company’s activities and how top management uses budget
information.
• Rather than using the budget as something to be achieved at all costs, management should use
the budget as a means of establishing goals, measuring results and determining areas that need
attention. Budgets should establish achievable but challenging months

4. The budget can coordinate the company’s activities by forcing department managers to consider how
the functions of their various departments are interrelated. Planned change to products or to products
focus will affects how the product is manufactured and how it is marked and will affect the financing
needed to fund operations. A failure to achieve goals by one function of the company may cause
another function to have to adjust its goals.
5. Flexible budgeting is a type of budgeting in which the budgeted amounts may be adjusted to any activity
level. Flexible budgeting allows to analyze variance better, because it shows the difference actual
amounts and the flexible budget amounts for the actual level activity; than static budget.
6. The other budget types include but are not limited to the following: Project budgeting Activity-based
budgeting, Zero-based budgeting, Continuous (Rolling) budgeting.
Case-5
Sara Hall is the production manager of a specialty toy manufacturer. The business has grown significantly over the past
several years. As the company grows, Sara has found it more difficult to manage all the various activities of purchasing,
production and quality control. In addition, the accounting department requires more and more feedback each month
as costs rise in the growing business. Hall attended a manufacturing conference where she heard about budgeting. The
toy manufacturer does not have a formal budgeting process and Sara thinks it might help the growing business. Hall is
not an accountant but is putting together a report to discuss the topic of budgeting with accounting.
Hall has done some studies on the current production processes. She has found that the company can produce a
maximum number of toys each month, but never actually reaches that level of production. One of the areas that has
become a significant issue in the growing business is stock- outs. Although Hall has been increasing the number of units
produced each month, the toy manufacturer’s sales department complains that they run out of toys at the beginning
of each month. The sales department has provided the following projections for sales over the next quarter.
Anticipated toy sales in units

October 10,000
November 12,000
December 15,000
Hall has determined that the production should reach a level so that there will be an ending inventory equal to 30% of
the next month’s sales.
1. Identify and explain four characteristics that could make this company’s budgeting process successful.
2. Describe how this business should differentiate between ideal standards and currently attainable standards.
5. Define budgetary slack. Identify and explain two ways this business can reduce the incidence and effect of
budgetary slack.

6. Based on information provided, prepare the toy company’s production budget for the month of November.
Show your calculations.
Answer:
1. Characteristics that define successful budgeting processes include:

• Top management involvement
• Participative or bottom-up approach which allows employee throughout the organization to
have input on the budget-setting process
• Promoting coordination between functional areas of the organization
• Providing communication and feedback throughout the process
• Using different budgets for planning than for performance evaluations to help alleviate some of
the behavioral issues with the budgeting process
• Using budgeting to motivate employees
• Setting clear goals and expectations at the beginning of a process
2. Ideal standards, also known as theoretical standards, can only be achieved under perfect conditions.
Currently attainable standards, also known as practical standards, can be achieved under normal
conditions. Normal conditions allow for reasonable downtime such as shift changes, machinery
maintenance, and employee training.
3. Machines need downtime for maintenance. Workers need downtime for rest. Set-ups for new production
runs may take time. Materials, machines may break; operator error may occur.
4. Stock-outs means disappointed customers, sales lost to competitors. Stock-outs may lead to rush
productions, incurring overtime, more errors, rush shipments of materials.
5. Budgeted slack occurs when employees attempt cushion budgets by either understating projected sales
or overstating projected cost. Employees do this in order to make sure they will meet the budget later at
the end of the period. Employees may also do this in order to appear that they have exceeded
expectations. Budgetary slack will hurt the organization because it misleads management about the true
positions of the organization. Budgetary slack can lead to inefficient resource planning and poor
coordination of activities within the organization.
Business can reduce the incidence and effect of budgetary slack by:
• Use budgets for planning but nor evaluations.
• Give rewards for accurate, as well as high budgets.
• Use additional measures for evaluation in additional to budget success.
• Have managers learn more about subordinates’ day-to-day work.
• Use external benchmark performance measures.

6. Production Budget for November
Anticipated Sales (in units) 12,000
Add: desired ending inventory
(30% * Dec sales 15,000) 4,500
Less: beginning inventory
(30%* Nov sales 12,000) 3,600
________
Units to produce 12,900
Case - 6
The executives at Stark Inc., a plumbing supply manufacturer, recently reviewed production capacity for the upcoming
year and set production budgets. Based on the number of units that they expected to produce, they budgeted sales
and set sales targets for each of their retail locations. They did not ask for the input of the individual store managers as
they believed that they had sufficient information and they wanted to ensure that the store targets were not easily
attainable. When the actual sales numbers started to come in, they were much lower than the budget. In investigating
the variance, the company found that one location had a new competitor that had opened just down the street, and
another had significant road construction that impeded the traffic flow and cut down on customers. There were also
some new products on the market that were cutting into the company’s market share. Because of the missed sales
budget, the company had over-produced resulting in excess inventory.
1. Explain the role of a sales budget in the development of the annual profit plan.
2. Identify four factors that should be considered when preparing a sales forecast.
3. Which two factors did management fail to consider in this scenario and what was the impact?
4. Discuss authoritative and participative budgets and identify which type is described in the scenario.
5. Identify and describe two best practice guidelines for the budget process.
6. Identify and describe four characteristics that define a successful budgeting process.
7. Discuss the financial impact of excess inventory.
Answer:
1. The sales budget is often regarded as the cornerstone of the entire budget. A firm attains its desired
goals through sales. Almost all activities of a firm emanate from efforts to attain sales goals and sales
growth. An inaccurate sales forecast can entire budget a futile exercise and imposes costly to the
company as well as its supplies.
2. The sales budget should consider:
• Current sales level and sales trends of the past few years
• General economic and industry conditions
• Competitors actions and operating plans

• Pricing policies
• Credit policies
• Advertising and promotional activities
• Unfilled back orders.
3. The company failed to consider competitor’s actions as well as general conditions of the company’s
retail locations. The impact was missed sales, over-production and excess inventory.
The company did not prepare the budgets in the right order. Sales budget should be set first based on
sales forecast then the production budget will be set based on budgeted sales, beginning inventory
and desired ending inventory. The company sets sales targets based on the number of units they
expected to produce which is reverse from the correct order and failed to consider beginning and
desired ending inventory.
4. Authoritative budgeting is a top-down budgeting process where top management prepares the
budget for the entire organization, including lower level operations. It provides better decision-
making control than participative budgets. Top management sets overall goals and prepare a budget
for operations to attain the goals. However, this type of budget often lacks the commitment of lower
level managers and employees responsible for implementing. Also, it doesn’t communicate, is dictates
and people are more likely to resent orders and are more willing to work attain goals they perceive as
their own.
Participating budgeting is a bottom up approach that involves the people affected by the budget,
including lower level employer in the budgeting process. It is a good communications device The
process of preparing a budget often gives top management a better grasp of the problems their
employees face and provides the employees a better understanding of the dilemmas that the top
management deals with. A participative budget I more likely to gain employee commitment to fulfill
the budgetary goals unless controlled, though: it can lead to easy budget targets or targets not in
compliance with the organization’s strategy or budget, Effective budgeting processes often combine
both approaches.
This company used authoritative budgeting as they did not talk to lower level manager, which may
have helped them identify the new competitors and construction issues.
5. The budgeting processes should include the formation a budget committee, determination of the
budget period, specification of budget guidelines, preparation of the initial budget proposal, budget
negotiation, review, and approval, and budget revisions.
A budget committee oversees all budget matters and usually consists of at least one senior manager.
The committee issues budget guidelines based on plans emanating from the reviews of the firm’s
strategy, external and internal factors goals and objectives of the budget period, and experience
gained from implementing the current budget. Based on the budget guidelines, managers prepare
initial budgets and discuss and negotiate their budget proposal with superiors. The budget committee
or the chief executive officer gives the final approval of the budget.
10 | E s s a y Q u e s t i o n a n d A n s w e r s S h e e t
6. Common factors of successful budget share many factors. Most important is acceptance and support
of the budget by all managers and employees. A successful budget often becomes a personalized
budget of the people who have the responsibility for carrying it out because they feel it is their budget,
not a detached, impersonal institutional budget. They own the budget and are the ones who bring
the budgeted goals to fruition. A budget is more likely to be successful if employees perceive it as a
planning and coordinating tools to help them to do their jobs, not as a pressure device to squeeze the
last drop of their energy out of them. Nor is budget likely to be an asset if it is viewed as a tool for
management to place blame. A successful budget is a better operating result. It is never used as an
excuse for not doing things strategically important to the organization. The expression “not in the
budget” never crops up at an organization with a successful budget A successful budget always has
technically correct and reasonably accurate numbers. A technically incorrect budget is likely to be
ignored. A budget with inaccurate numbers will fail to gain confidence and be rendered useless.
7. Excess inventory impacts financials in the following ways:
• Consuming large warehouse space.

• Costing additional fees until or sales of the inventory, e.g. warehousing fees.
• Increasing the risk of inventory obsolesces.
• Using company’s funds.
Section C - Performance Management
Case-7
Coe Company is a manufacturer of semi-custom motorcycles. The company used 500 labor hours to produce a
prototype of a new motorcycle for one of its key customers. The customer then ordered three additional motorcycles
to be produced over the next six months. Coe estimates that the manufacturing process for these additional
motorcycles is subject to a 90% learning curve. Although the production manager was aware of the learning curve
projections, he decided to ignore the learning curve when compiling his budget in order to provide a cushion to
prevent exceeding the budgeted amount for labor.
1. By using the cumulative average-time learning curve, estimate the total number of labor hours that are
required to manufacture the first four units of product. Show your calculations.
2. Assume the 90% learning curve is realized. Calculate Coe’s cost savings in producing the three additional
units if the cost of direct labor is $25 per hour. Show your calculations.
3.
a. . Define budgetary slack.
11 | C M A U S ( P a r t I ) Complied By: Prof. Ravi Gupta

b. Identify and explain two negative effects that budgetary slack can have on the budgeting process.
4. Assume that Coe actually used 1,740 labor hours to produce the four units at a total cost of $44,805.
a. If the company ignored the learning curve when creating the budget, for the four units produced,
compute Coe’s:
1. direct labor rate (price) variance.
2. direct labor efficiency (quantity) variance.
b. How would the above two variances differ if the learning curve had been considered when creating the
budget? Show your calculations.
5. Assume that the price variance is unfavorable and the efficiency variance is favorable. Identify and discuss
one reason that explains both of these variances.
6. Explain the effect on the direct labor efficiency variance if the manufacturing process were subject to an 80%
learning curve.
7. Identify and explain one limitation of learning curve analysis in this situation.
Answer:
1. First unit: 500 hours.

First two units (first doubling): 500 *2*0.90 = 900 hours.
First four units (second doubling): 900*2*0.90 = 1,620 hours.
2. $25*500 hours* 4units = $50,000 cost with no learning curve.

$25*1,620 hours = $40,500 with 90% learning curve.
3.
a. budgetary slack is the practice of underestimating budgeted revenue or overestimating budgeted
costs to make budgeted targets more easily achievable.
b. Budgetary slacks mislead top management about the true profit potential of the company, which
leads to inefficient resource planning and allocation as well as poor co-ordination of activities across
different parts of the company.
4.
a. 1. Direct labor rate variance: (AP-SP) * AQ
Actual hours: 1,740
Actual cost: $44,805
Actual rate: $44,805 ÷ 1740 = $25.75
($25.5 - $25.00) * 1740 = $1,305 unfavorable
2. Direct labor efficiency variance (AQ – SQ) * SP

(1,740 – 2000) * $25.00 = $(6,500) Favorable
b. If the budgeted amount of hours had been 1,620 (using a 90% learning curve) instead of 2,000 (using no
learning curve), the direct labor rate variance would have been the same because the rate variance does
not make use of the budgeted number of hours. The direct labor rate variance formula is (AP – SP) * AQ,
and the variance would have been the same as in a.1. above ($25.75 - $25.00) * 1,740 = 1,305 unfavorable.
If the budgeted amount of hours had been 1,620 (using a 90% learning curve), the direct labor efficiency
variance would have been $3,000 Unfavorable. The direct labor efficiency variance formula is (AQ – SQ) *
SP, and the variance would have been (1,740 – 1,620) * $25.00 = $3,000 unfavorable.
5. A factor that could cause an unfavorable price variance and a favorable efficiency variance is using a
higher-skilled labor force that would be paid more per hour but would wok more quickly.
6. If the manufacturing process were subject to an 80% learning curve, the number of hours budgeted would
have been less than 1,620 because a lower percentage on the learning curve implies more benefit from
leaning. As a result, the direct labor efficiency variance would have been greater and more unfavorable.
7. For a new product, the company may not be able to accurately forecast the amount of improvement (if
any) from learning. The company may or may not be able to gain efficiencies from learning.
Case 8
Law Services Inc. provides a variety of legal services to its clients. The firm’s attorneys each have the authority to
negotiate billing rates with their clients. Law Services wants to manage its operations more effectively, and established
a budget at the beginning of last year. The budget included total hours billed, amount billed per hour, and variable
expense per hour. Unfortunately, the firm failed to meet its budgeted goals for last year. The results are shown below.
Actual Budget
Total hours billed 5,700 6,000
Amount billed/hour $275 $325
The budgeted variable expense per hour is $50, and the actual total variable expense was $285,000. There is
disagreement among the attorneys over the reasons that the firm failed to meet its budgeted goals.
1. What is the advantage of using a flexible budget to evaluate Law Services’ results for last year as opposed to
a static budget? Explain your answer.
2. Explain the process of creating a flexible budget for Law Services. Calculate the total static budget revenue
variance, the flexible budget revenue variance, and the sales-volume revenue variance. Show your
calculations.
3. Calculate the total static budget revenue variance, the flexible budget revenue variance, and the sales-
volume revenue variance. Show your calculations.

4.
a. . Calculate the variable expense variance. Show your calculations.
b. Was the variable expense variance a flexible budget variance or a sales volume variance? Explain
your answer.
Answer:
1. A flexible budget allows the attorneys to tell how much of their unfavorable variance is due to lower than
planned billing hours and how much is due to performance issues such as the negotiated billed amount
or variable expenses. A master budget is static and any variance must be analyzed further to determine
its cause.
2. The flexible budget revenues are calculated by multiplying the actual billed hours by the budgeted amount
per billed hours. Then the budgeted variable expenses per billed hours is multiplied by the actual billed
hours. The flexible budget variable expense is subtracted from the flexible budget revenue. The results
are compared to the actual results from last year.
3. 5,700 * $275 = $1,567,500 actual revenue

6,000 * $325 = $1,950,000 static budget revenue
$1,567,500 - $1,950,000 = $(382,500) unfavorable static budget revenue variance
5,700 * $325 = $1,852,500 flexible budget revenue
$1,567,500 - $1,852,500 = $(285,000) unfavorable flexible budget variance
(5,700 – 6000) * $325 = $(97,500) unfavorable sales volume variance
4.
a. Actual variable expense (given) was $285,000. Actual total hours billed was 5,700, so the actual
variable expense per hour was $285,000 ÷ 5,700, or $50/hours. The actual hourly rate was the same
as the budgeted hourly rate.
Static budget variable expense variance was $285,000 - $300,000 = $(15,000) favorable.
b. The full amount of the static budget variance ($15,000favorable) was a sales volume variance, for two
reasons:
1. The flexible budget amount is 5,700 * $50 = 285,000,
Which is the same as the actual variable expense; this the flexible budget variance zero, the
variance must be a sale volume variance.
2. The actual hourly rate ($50) is the same as the budgeted hourly rate ($50), so the static budget
variance is exclusively the result of the variance in sale volume.
Case- 9
WoodCrafts Inc. is a manufacturer of furniture for specialty shops throughout the northeast and has an annual sales
volume of $12 million. The company has four major product lines − bookcases, magazine racks, end tables, and bar
stools − each of which is managed by a production manager. Since production is spread fairly evenly over the 12 months
of operation, Sara McKinley, controller, has prepared an annual budget that is divided into 12 reporting periods for
monthly reporting purposes.
WoodCrafts uses a standard cost system and applies variable factory overhead on the basis of machine hours. Fixed
production cost is allocated on the basis of square footage occupied using a predetermined plant-wide rate; the size of
the space occupied varies considerably among product lines. All other costs are assigned on the basis of revenue dollars
earned. At the monthly meeting to review November performance, Ken Ashley, manager of the bookcase line, received
the report shown below.
WoodCrafts Inc.
Bookcase Production Performance Report
For the Month Ended November 30, 2008
Actual Budget Variance

Units 3,000 2,500 500F
Revenue $161,000 $137,500 $23,500F
Variable production costs:
Direct material 23,10 20,000 3,100U

Direct labor 18,300 15,000 3,300U
Machine time 19,200 16,250 2,950U
Factory overhead 41,000 35,000 6,000U
Fixed production costs:
Indirect labor 9,400 6,000 3,400U

Depreciation 5,500 5,500 —
Taxes 2,400 2,300 100U
Insurance 4,500 4,500 —
Administrative expense 12,000 9,000 3,000U
Marketing expense 8,300 7,000 1,300U

Research and development 6,000 4,500 1,500U
Operating profit $ 11,300 $ 12,450 $ 1,150U
1. Identify at least three weaknesses in WoodCrafts Inc.’s monthly Bookcase Production Performance
Report.
2. WoodCrafts Inc. could do a better job of reporting monthly performance to the production managers.
Recommend how the report could be improved to eliminate weaknesses.

Answer:
1. At least three weakness in Woodcrafts Inc.’s monthly Bookcase production performance report
include:
• The report being based on a static budget. Woodcrafts should use a flexible budget that
compares the same level of activity, calculating variances between the actual results and the
flexible budget. Also, Woodcrafts might implement an activity-based cost system.
• Costs over which the supervision have no control, such as fixed production costs and
allocated overhead costs.
• Using a single plant-wide rate to allocate fixed production costs. Square footage may not
drive the fixed production costs, and there may be a more appropriate base such as number
of units produced. It may be more appropriate to develop different bases of allocation for
each of the different product lines.
2. To improve the monthly performance report, Woodcrafts Inc. should:

• Use a flexible budget.
• Hold supervision responsible for only those costs over which they have control by using a
contribution approach.
• Include footnotes to make the report more understandable.
Case - 10
For many years, Lawton Industries has manufactured prefabricated houses where the houses are constructed in
sections to be assembled on customers’ lots. The company expanded into the pre-cut housing market in 2016 when it
acquired Presser Company, one of its suppliers. In this market, various types of lumber are pre-cut into the appropriate
lengths, banded into packages, and shipped to customers’ lots for assembly. Lawton decided to maintain Presser’s
separate identity and, thus, established the Presser Division as an investment center of Lawton.
Lawton uses return on investment (ROI) as a performance measure. Management bonuses are based in part on ROI. All
investments in assets are expected to earn a minimum return of 15% before income taxes. Presser’s ROI has ranged
from 19.3% to 22.1% since it was acquired in 2016. The division had an investment opportunity in the year just ended
that had an estimated ROI of 18% but Presser’s management decided against the investment because it believed the
investment would decrease the division’s overall ROI.
Presser’s operating statement for the year just ended is presented below. The division’s assets were $12,600,000 at the
end of the year.
PRESSER DIVISION OPERATING STATEMENT

FOR THE YEAR ENDED DECEMBER 31
($000 OMITTED)
SALES REVENUE $24,000
COST OF GOODS SOLD 15,800
GROSS PROFIT $ 8,200
OPERATING EXPENSES
ADMINISTRATIVE $2,140
SELLING 3,600 5,740
INCOME FROM OPERATIONS
BEFORE INCOME TAXES $ 2,460
A. Calculate the following performance measures for the year just ended for the Presser Division of Lawton
Industries.
1)Return on investment (ROI).

2)Residual income (RI)
B. Would the management of Presser Division have been more likely to accept the investment opportunity it
had during the year if residual income were used as a performance measure instead of ROI? Explain your
answer.
C. The Presser Division is a separate investment center with Lawton Industries. Identify and describe the items
Presser must control if it is to be evaluated fairly by either the ROI or residual income performance
measures.
Answer:
A. ROI = operating income of business unit divided by assets of business unit

= $2,460,000 ÷ ($12,600,000 * 0.15) = $570,000.
Residual income = operating income of business unit minus (Assets of the business unit * required rate
of return).
RI = $2,460,000 – ($12,600,000 * 0.15) = $570,000
B. Yes, presser’s management probably would have accepted the investment if residual income were used.
The investment opportunity would have lowered presser’s ROI because the expected return (18%) was
lower than the division’s historical returns as well as its actual ROI (19.5%) for the year just ended.
Management rejected the investment because bonuses are based in part on the performance measures
of ROI. If residual income were used as a performance measure (and as a basis for bonuses), management
would accept any and all investments that would increase residual income including the investment
opportunity rejected in the year ended.
C. Presser must control all items related to profit (revenue and expenses) and investment if it is to be
evaluated fairly as an investment center by the either the ROI or residual income of performance
measures. Presser must control all elements of the business except the cost of invested capital, that being
controlled by Lawton industries.

Case - 11
Klein, Thompson’s CFO, has determined that the Motor Division has purchased switches for its motors from an outside
supplier during the current year rather than buying them from the Switch Division. The Switch Division is operating at
full capacity and demanded that the Motor division pay the price charged to outside customers rather than the actual
full manufacturing costs as it has done in the past. The Motor Division refused to meet the price demanded by the
Switch Division. The Switch Division contracted with an outside customer to sell its remaining switches and the Motor
division was forced to purchase the switches from an outside supplier at an even higher price.
Klein is reviewing Thompson’s transfer pricing policy because she believes that sub- optimization has occurred. While
Klein believes the Switch Division made the correct decision to maximize its divisional profit by not transferring the
switches at actual full manufacturing cost, this decision was not necessarily in the best interest of Thompson.
Klein has requested that the corporate Accounting Department study alternative transfer pricing methods that would
promote overall goal congruence, motivate divisional management performance, and optimize overall company
performance. The three transfer pricing methods being considered are listed below. One of these methods will be
selected, and will be applied uniformly across all divisions.
• Standard full manufacturing costs plus markup.

• Market selling price of the products being transferred.
• Outlay (out-of-pocket) costs incurred to the point of transfer plus opportunity cost per unit.
1. Identify and explain two positive and two negative behavioral implications that can arise from employing a
negotiated transfer price system for goods that are exchanged between divisions.
2. Identify and explain two behavioral problems that can arise from using actual full (absorption)
manufacturing costs as a transfer price.
3. Identify and explain two behavioral problems most likely to arise if Thompson Corporation changes from its
current transfer pricing policy to a revised transfer pricing policy that it applies uniformly to all divisions.
4. Discuss the likely behavior of both “buying” and “selling” divisional managers for each of the following
transfer pricing methods being considered by Thompson Corporation.
a. Standard full manufacturing costs plus markup.

b. Market selling price of the products being transferred
c. Outlay (out-of-pocket) costs incurred to the point of transfer plus opportunity cost per unit.
Answer:
1. The positive and negative behavioral implications arising from employing a negotiated transfer price
system for goods exchanged between divisions include the following:
Positive
• Both the buying and selling divisions will participate in the negotiations and are likely to believe
they have agreed on the best deal possible.
• Negotiating and determining transfer prices will enhance the autonomy/in dependence of both
divisions.
Negative
• The result of a negotiated transfer price between divisions may not be optimal for the firm as a
whole and therefore will not be goal congruent.
• The negotiate process may cause harsh feelings and conflicts between divisions.
2. The behavioral problems which can arise from using actual full (absorption) manufacturing costs as a
transfer price include the following:
a. Full-cost transfer pricing is not suitable for a decentralized structure when the autonomous divisions
are measured on profitability as the selling unit is unable to realize a profit.
b. This method can lead to decisions that are not goal congruent if the buying unit decides to buy
outside at a price less than the full cost of the selling unit. If the selling unit is not operating at full
capacity, it should reduce the transfer price to the market price if this would allow the recovery of
variable costs plus a portion of the fixed costs. The price reduction would optimize overall company
performance.
3. The behavioral problems that could arise, if Thompson Corporation decides to changes its transfer
pricing policy to one that would apply uniformly to all divisions, including the following:
• A change in policy may be interpreted by the divisional managers as an attempt to decrease
their freedom to make decisions and reduce their autonomy. This perception could lead to
reduce motivation.
• If managers lose control of transfer prices and this, some control over profitability they will be
unwilling to accept the change to uniform prices.
• Selling divisions will be motivated to sell outside if the transfer price is lower than market as this
behavior is likely to increase profitability and bonuses.
4. The likely behavior of both “buying” and “selling” divisional managers, for each of the following transfer
pricing method being consider by Thompson Corporation include the following:
a. Standard full manufacturing costs plus a markup.
The selling division will be motivated to control costs because any costs over standard cannot be
passed on to the buying decision will reduce the profit of the selling division.

The buying division may be pleased with this transfer price if the market price is higher. However, if
the market price is lower and the buying divisions are forced to take the transfer price, the
managers of the buying division will be unhappy.
b. Market selling price of the product being transferred

This is creating a fair and equal chance for the buying and selling divisions to make the most profit
they can. It should promote cost control, motivate divisional management, and optimize overall
company performance. Since both parties are aware of the market price, there will be no distrust
between the parties, and both should be willing to enter into the transaction.
c. Outlay (out-of-packet) costs incurred to the point of transfer, plus opportunity costs per unit.
This method is the same as market price when there is an established market price and the seller is at
full capacity. At any level below full capacity, the transfer price is the outlay cost only (as there is no
opportunity cost), which would approximate the variable costs of the goods being transferred.
Both buyers and sellers should be willing to transfer under this method because the price is the best
either party should be able to realize for the product under the circumstances. This method should
promote overall goal congruence, motivate managers, and optimize overall company profits.
Case - 12
Blue Mountain operates retail stores throughout the United States. Blue Mountain has three divisions, where each
operates their own independent retail stores: Apparel, Shoes and Sports Equipment. The manager of each division is
responsible for the revenues and costs of the division. All investment decisions are made by the corporate
headquarters. Blue Mountain had a history of financial success until last year when it incurred a net loss of $250,000.
President Bob Johnson does not understand why the company incurred a loss and has assigned accountant Hillary
Ryan with the job of analyzing the results.
Last Year’s Operating Results

Sales $7,500,000
Variable expenses 4,000,000
Fixed expenses 3,750,000
Net loss ($250,000)
A breakout of operating data by division is shown below.
APPAREL SHOES SPORTS

EQUIPMENT
REVENUES $3,750,000 $1,500,000 $2,250,000
VARIABLE 1,500,000 500,000 2,000,000
EXPENSES
Ryan analyzed fixed expenses and found that $1,000,000 is traceable to Apparel, $750,000 is traceable to Shoes, and
$1,500,000 is traceable to Sports Equipment. The remaining fixed expenses relate to the corporate headquarters.
1. Identify and describe the four types of responsibility centers.
2. What type of center do the three retail divisions of Blue Mountain represent?
3. How should Blue Mountain allocate the fixed expenses when evaluating the performance of the
three retail divisions? Explain.
4. Calculate the contribution margin for each division. Show your calculations.
5. Which division of Blue Mountain is the most unprofitable one and how can Blue Mountain improve this
division’s profitability? Explain you answer. No calculations necessary.
6. Discuss how contribution margin can be used as a performance evaluation tool.
Answer:
1. Cost center: manager is responsible for controlling only the costs of the segment.
Revenue center: manager is responsible for controlling only the revenue of the segment
Profit center: manager is responsible for controlling both the revenues and the costs of the segment.
Investment center: manager is responsible for controlling the revenues, cost and the investment of assets
of the segment.
2. The three retail divisions at blue mountain represent profit centers.
3. When evaluating the performance of profit centers, use a segmented income statement approach which
calculate segment margin. under this approach, costs that are controllable by the manager ae separated
from the costs that are not controllable. For Blue Mountain, only the variable expenses and traceable
fixed costs, such as the corporate headquarters, should not be allocated to the divisions to the division
when evaluating performance.
4. Contribution margin by division
Apparel Shoes Sports Equip. Total

Sales $3,750,000 1,500,000 2,250,000 7,500,000
Less: variable 1,500,000 500,000 2,000,000 4,000,000
expenses
Contribution 2,250,000 1,000,000 250,000 3,500,000
margin

5. Sports Equipment is the unprofitable division. The division’s contribution margin is not high enough to
cover its traceable fixed expenses.
Apparel Shoes Sports Equip. Total

Sales $3,750,000 1,500,000 2,250,000 7,500,000
Less: variable 1,500,000 500,000 2,000,000 4,000,000
expenses
Contribution 2,250,000 1,000,000 250,000 3,500,000
margin
Less: traceable 1,000,000 750,000 1,500,000 3,250,000
fixed expenses
Segment Margin 1,250,000 250,000 (1250,000) 250,000
Less: common 500,000
fixed expenses
Net loss (250,000)
Improve this division’s performance, Blue Mountain needs to either increase the division’s contribution margin or
decrease the traceable fixed expenses. To increase the contribution margin, either the sales price needs to
increase, or the variable expenses need to decrease. To decrease traceable fixed expenses, management should
analyze all the fixed expensed traced to the division to see if they could be reducing or eliminated.
6. Contribution margin is the difference between total revenues and operations costs. It explains why
operating income changes as the number of units sold changes. It helps to evaluated if sales volume is
sufficient to insure profitability. Contribution margin contribution to covering fixed costs and it is a
critical component in breakeven (cost/volume/profit analysis) to determine if sales are sufficient.
Case - 13
Maxwell Mechanical Inc. specializes in servicing central air conditioning units. Maxwell Mechanical employs licensed
HVAC technicians and apprentices. Each service call requires a combination of both types of labor.
Maxwell’s standard time and cost for each service call are as follows.
TIME WAGE
HVAC TECHNICIAN 1.0 hour $30/hour
APPRENTICE 3.0 hours $14/hour
During the month of May, Maxwell serviced 1,500 air conditioning units. HVAC technicians worked a total of 1,900
hours with a total labor cost of $60,800.
Apprentices worked a total of 4,000 hours with a total labor cost of $52,000. The service calls require a certain
amount of direct materials. For the month of May, Maxwell experienced a favorable direct materials price variance of
$5,000 and an unfavorable direct materials usage variance of $8,000.
1. Explain how Maxwell could use management by exception.

2. Calculate Maxwell’s total direct labor rate variance for the month of May. Show your calculations.
3. Calculate Maxwell’s total direct labor efficiency variance for the month of May. Show your calculations.
4. Without performing any calculations, explain how Maxwell could further analyze the labor efficiency
variance.
5. Identify one possible cause and one corrective action for the combination of a
favorable direct materials price variance and an unfavorable direct materials usage variance experienced by
Maxwell in May.
Answer:
1. Management by exception means management focuses attention on areas that are not performing or
meeting expectations. Management spends less time on areas that are operating effectively. Maxwell
can use management by exception by focusing on the unfavorable direct materials usage variance. It
could also look at units serviced or total labor costs if they varied significantly from budget planned
result.
2. Total direct labor rate variance $200F
AQ * AP AQ*SP Variance
HVAC technicians 1900*$32=$60,800 1900*$30=$57,000 $3,800U
Apprentice 4000*$13=52,000 4000*$14=$56,000 $4,000F
$200F
3. Total direct labor efficiency variance $5000U

AQ * AP AQ*SP Variance
HVAC technicians 1900*$30=$57,000 1500*$30=$45,000 $12,000U
Apprentice 4000*$14=56,000 4500*$14=$63,000 $7,000F
$5,000F
*SQ = 1500 * 1 hour
**SQ = 1500 * 3 hour
4. Maxwell has two substitutable labor inputs. The labor efficiency variance could be further analyzed by
breaking down the variance into the mix variance and yield variance. The mix variance analyzes the
difference between actual and standard input proportions. The yield variance analyzes the difference
between actual and standard inputs used.

5. Favorable direct materials variance combined with unfavorable direct material variance: Maxwell
purchased cheaper, lower quality materials. These lower quality materials caused increased waste. Since
the unfavorable usage variance was greater than the favorable direct materials variance, Maxwell
should correct purchasing policies to ensure quality material are purchased.
Case - 14
TOR Industries sells raw materials to its customers in the appliance manufacturing business. Rochelle Smith, a recently
hired financial analyst, has been asked to evaluate the profitability of TOR’s three biggest customers, A, B, and C,
respectively. Smith has been provided with the following information.
1. Identify which customer has the highest operating profit margin percentage based on net revenue. Show
your calculations.
2. Identify three factors that are contributing to this higher profit margin percentage.
3. The sales department has been given the goal of increasing the gross profit margin from customer C by
$25,000 next year. If the gross profit margin percentage remains at its current level, how much more in
revenue, net of discounts, is required to meet this gross profit goal? Show your calculations.
4. Recommend and explain three improvements in operations that would decrease customer operating costs
and increase customer profitability.
5. Assume that each shipment is sent to the customer directly and each truck can hold up to 500 units. To
minimize shipping costs, how many times per year should customer C be ordering? Show your calculations.
6. From the customer’s perspective, discuss the potential costs and benefits of reducing the number of
shipments per year.
Answer:
1. Operating profit margin percentage = operating income /Net revenue

Customer A operating profit margin percentage = $292,332/$675,000=43.31%
Customer B operating profit margin percentage = $221,440/$508,000=43.59%
Customer C operating profit margin percentage = $187,816/$425,000=44.19%
2. The higher percentage is due to having the lowest level of discounts per unit, having larger order sizes
(therefore lower shipping costs per unit and fewer order taking charges) and lower selling costs per unit
sold.
3. For the Sale Department to deliver $25,000 more of gross profit at a 50% gross profit margin they would
need to increase net revenue by $25,000/50%= $50,000.
4. Product handling – costs can be reduced by working with customer to order in full pallet quantities
(reducing pallet breakdowns and re-palletizing cost, and the number of pallets used in shipping). Also,
fewer orders reduce the paperwork in the warehouse.
Order taking – fewer purchase orders reduces the amount of administrative work to support the picking
and shipping of products, as well as administrative overhead related to order- entry, accounts receivable
and credit and collection work. There may be savings opportunities from automating the ordering process
(EDI, linked systems)
Delivery – by filling trucks and minimizing the number of trips, shipping labor, fuel, fleet maintenance,
and delivery wait-times and in loading costs can be reduced.
Rush orders - by working with customers in better managing inventory levels, rush order can be reduced
or eliminated, resulting in lower costs and higher sales (from reduced stock-outs)
Visit to customers – by working more closely with customers there is opportunity to increase profitability
for both the customer and supplier. Spending more could make sense here if it leads to deepening the
relationship with customer to identify shared savings opportunities. With mature customer relationship,
visit to customers add value if they are fact based and seek to deepen relationship by more closely trying
the supplier to the customer’s processes and aim to reduce costs for both sides and expand margin.
5. Customer C should be ordering 50 times per year (25,000 per year / 500 units per shipment).

6. From the customer’s pint of view, more frequently ordering helps to minimize the amount of stock needed
to be kept on hand, reducing carrying costs. However, this needs be weighed against the costs of re-order
and potential lost sales and/or production down-time from out-of-stock event.
Case - 15
Five years ago, Arlington Industries expanded vertically by acquiring one of its suppliers, Raddix Plastics. Arlington
monitors its divisions based on both product contribution and return on investment (ROI), with investment defined as
average operating assets employed. All investments in operating assets are expected to earn a minimum return of 11%
before income taxes. Management bonuses are also determined based on ROI. The cost of goods sold at Raddix is fully
variable while administrative expenses are not dependent on sales volume. Selling expenses are a mixed cost with 40%
attributed to sales volume. Since Arlington acquired Raddix, the ROI at Raddix has ranged from 11.8% to 14.7%. During
the fiscal year just ended, Raddix considered a capital acquisition with an estimated ROI of 11.5%; however, division
management decided against the capital acquisition because it believed that the capital acquisition would decrease the
division’s ROI. The abbreviated most recent income statement for Raddix is presented below. The division’s operating
assets employed were $15,750,000 at year end, a 5% increase over the previous year-end balance.
1. Calculate the unit contribution margin for Raddix Plastics if 1,484,000 units were produced and sold during
the fiscal year ended December 31.
2. Based on the average operating assets employed, calculate return on investment (ROI) and residual income
(RI) for the Raddix Plastics division.
3. Explain why the management of Raddix Plastics would have been more likely to accept the proposed capital
acquisition if RI rather than ROI was used as a performance measure.
4. Identify one disadvantage for the organization to focus only on ROI and RI, respectively.
5. Raddix Plastics is a separate investment center within Arlington Industries. Identify three other types of
responsibility centers.
6. Identify the items that Raddix should control if it is to be evaluated fairly by using the ROI or RI performance
measures.
Answers:
1. Unit contribution = {$25,000,000 – [$16,500,000 + ($2,700,000]} ÷ 1,484,000

= $7,420,000 ÷ 1,484,000 = $5.00 per unit
2. Average assets = [$15,750,000 + (15,750,000 ÷ 1.05)] ÷ 2
= (15,750,000 + 15,000,000) ÷ 2
= $15,375,000
ROI = operating income ÷ average assets

= $1,845,000 ÷ 15,375,000
= 12%
Residual Income = operating income – mini required return on average assets
= $1,845,000 – ($15,375,000 * .11)
= $153,750
3. Raddix management would be more likely to accept the proposed capital acquisition as residual income was
used as a performance measure because the acquisition would have increased both the division’s residual
income and the management bonuses. Using residual income, management would accept any investment
with a return higher than 11% as all would increase the dollar value of residual income. With ROI as a
measurement, Raddix would reject any investment with a return lower than 12% as this would lower overall
return and lower bonuses.
4. RI is a flat dollar amount which makes comparing business units of different sizes
difficult. ROI may lead managers to reject investment opportunities with a lower ROI which is lower than
current or targeted RLI but is strategically beneficial to the organization as a whole.
5. Three other type of responsibility center are cost center, revenue center, and profit center.
6. To be evaluated fairly as an investment center, Raddix must control all items related to profit and investment.
The division should control all elements of the business except the cost of invested capital which would be
controlled by Arlington.

Section D - Cost Management
Case - 16
TruJeans, a new startup company, plans to produce blue jean pants, customized with the buyer’s first name stitched
across the back pocket. The product will be marketed exclusively via an internet website. For the coming year, sales
have been projected at three different levels: optimistic, neutral, and pessimistic. TruJeans does keep inventory on
hand, but prefers to minimize this investment.
The controller is preparing to assemble the budget for the coming year, and is unsure about a number of issues,
including the following.
• The level of sales to enter into the budget.

• How to allocate the significant fixed costs to individual units?
• Whether to use job order costing or process costing.
In addition, the controller has heard of kaizen budgeting and is wondering if such an approach could be used by
TruJeans.
1. How can the controller use the expected value approach to set the sales level for the budget? What
additional information would be needed?
2. How could the use of variable (direct) costing mitigate the problem of how to allocate the fixed costs to
individual units?
3. Which cost system seems to make more sense for TruJeans, job order costing or process costing? Explain
your answer.
Answer:
1. The sales staff has not presented the controller with unique expected level of sales, but rather sales
numbers under various scenarios. The controller could use the expected sales in the budget, which is the
summation of the anticipated sales under each scenario times the profitability of that scenario. The
controller would need to estimate the profitability of each scenario in order to complete the task.
2. Under direct costing, fixed manufacturing costs are expensed rather than being added to the inventoriable
cost of each unit. This, is not necessary to determine the allocation of fixed costs to individual units.
3. At first glance, job order costing appears to make more sense, as each pair of jeans is literally unique,
given that buyer’s name is stitched on the back pocket. However, in reality, process costing should be
used, because jeans will be produced continually, and for cost purposes, will be same for each pair.
Case - 18
Many companies recognize that their cost systems are inadequate for today’s powerful global competition. Managers
in companies selling multiple products are making important product decisions based on distorted cost information, as
most cost systems designed in the past focused on inventory valuation. In order to elevate the level of management
information, it has been suggested that companies should have as many as three cost systems for (1) inventory
valuation, (2) management control of operations, and (3) an activity-based costing system for decision-making.
1. Discuss why the traditional cost system, developed to value inventory, distorts product cost information.
2. Identify the purpose and characteristics of each of the following systems.
a. Inventory valuation.
b. Management control of operations.
c. Activity-based costing.
3.
a. Describe the benefits that management can expect from activity-based costing
b. List the steps that a company using a traditional cost system would take to implement activity-based
costing.
Answer:
1. The traditional cost system, developed to value inventory, distorts product cost information because the
cost system
• Was designed to value inventory in the aggregate and not relate to product cost information.
• Uses a common departmental or factory-wide measures of activity, such as direct labor hours or
dollars (now a small portion of overall production costs) to distribute manufacturing overhead
to products.
• Deemphasizes long-term product analysis (when fixed costs become variable costs).
• Causes managers, who are aware of distortions in the traditional system, to make intuitive,
imprecise adjustments to the traditional cost information without understanding the complete
impact.
2. Outlined below are the purpose (1) and characteristics (2) of three noted cost systems.
Inventory valuation: (1) meeting external reporting requirements for aggregate balance sheet valuation
and income determination, (2) providing monthly and quarterly reporting.
Management control of operations: (1) evaluating operations in order to quickly detect problems to
allow implementation of corrective action, (2) comparing costs against budget for monitoring.
Activity-based costing: (1) differentiating costs between value adding and non-value adding activities, (2)
costing products according to activities involved in the production process.

3.
a. The benefits that management can expect from activity-based costing include the following:
• Leads to a more competitive position by evaluating cost drivers, e.g., costs associated with the
complexity of the transaction rather than the production volume.
• Streamlines production processes by reducing non-value adding activities, e.g., reduced set-up
times, optimal plant layout, and improved quality.
• Provides management with a more thorough understanding of product costs and product
profitability for strategies and pricing decisions.
b. The steps that a company, using a traditional cost system, would take implement activity-based
costing include the following.
• evaluation of the existing system to assess how well the system supports the objective of an
activity-based cost system
• identification of the activities for which cost information is needed with differentiation
between value adding and non-value adding activities.
Case - 18
Inman Inc. is a manufacturer of a single product and is starting to develop a budget for the coming year. Because cost
of goods manufactured is the biggest item, Inman’s senior management is reviewing how costs are calculated. In
addition, senior management wants to develop a budgeting system that motivates managers and other workers to
work toward the corporate goals. Inman has incurred the following costs to make 100,000 units during the month of
September.
Materials $400,000
Direct labor 100,000
Variable manufacturing overhead 20,000
Variable selling and administrative costs 80,000
Fixed manufacturing overhead 200,000
Fixed selling and administrative costs 300,000
Inman Inc.’s September 1 inventory consisted of 10,000 units valued at $72,000 using absorption costing. Total fixed
costs and variable costs per unit have not changed during the past few months. In September, Inman sold 106,000 units
at $12 per unit.
1. Using absorption costing, calculate the following.

• Inman’s September manufacturing cost per unit
• Inman’s September 30 inventory value
• Inman’s September net income
2. Using variable costing, calculate the following.
• Inman’s September manufacturing cost per unit

• Inman’s September 30 inventory value
• Inman’s September net income
3. Identify and explain one reason why the income calculated in the previous two questions might differ.
4. Identify and discuss one advantage of using each of the following:

• absorption costing
• variable costing
5.
• Identify one strength and one weakness each of authoritative budgeting and participative
budgeting.
• Which of these budgeting methods will work best for Inman Inc.? Explain your answer.
• Identify and explain one method the top managers can take to restrict the Production Manager from
taking advantage of budgetary slack.
Answer:
1. Absorption costing
a. September manufacturing cost per unit:
Cost to manufacture 100,000 units = $400,000 materials + $100,000 direct labor + $20,000 variable
manufacturing overhead + $200,000 fixed manufacturing overhead
= $720,000
Cost per unit = $720,000 ÷ $100,000 = $7.20 per unit
b. September 30 inventory value:

10,000 units beginning inventory + 1,00,000 units manufactured – 106,000 units sold = 4,000 units
ending units = 4,000 units in ending inventory. 4,000 units in ending * $7.20 cost per unit = $28,800
September 30 inventory value.
c. September net income

sales = 106,000 units sold * $12 price per unit = $1,272,000
cost of goods sold = beginning inventory $72,000 + COGM $720,000 – ending inventory $28,800 =
$763,200
Gross profit = $1,272,000 – $763,200 = $508,800
Selling and administrative expenses = $80,000 variable costs + $300,000 fixed costs = $380,000
Net income = $508,800 gross profit - $380,000 selling and administration expenses = $128,800

2. Variable costing
a. September Manufacturing cost per unit:
Cost manufacture 100,000 units = $400,000 materials + 100,000 direct labor + $20,000 variable
manufacturing overhead = $520,000.
b. September 30 inventory value

4000 units * $5.20 per units = $20,800
c. September net income:

Sales 106,000 units sold * $12 price per unit = 1,272,000
Variable cost and contribution margin:
Variable manufacturing cost: $5.20 * 106,000 = $551,200
Variable selling and administrative expenses: $80,000
Total variable costs $551,200 + $80,000 = $631,200
Contribution margin = Sales $1,72,000 – Total variable cost $631,200 = $640,800
Fixed cost:
Fixed manufacturing costs $200,000 + Fixed selling & administrative expenses $300,000 = $500,000
Net income = $640,800 contribution margin - $500,000 fixed manufacturing, selling and
administrative expenses = $140,800
3. The difference in income is caused by the treatment of fixed manufacturing overhead. Absorption costing
treat this cost as a product cost that is held in inventory until the goods are sold; variable costing treat
fixed manufacturing overhead as a period costing would expense all of the current month’s fixed
manufacturing overhead as well as some of the costs that were previously deferred in the prior period ‘s
inventory; variable costing would only expense the current month’s amount, resulting in a higher income.
4.
a. The advantages of using absorption costing are:

• It is required for external reporting.
• It matches all manufacturing cost with revenues.
b. The advantages of using variable costing are:
• Data required for cost-volume-profit analysis can be taken directly from the statement.
• The profit for a period is not affected by changes in inventories.
• Unit product costs do not contain foxed cost that are often utilized, practice that could
result in poor decision –making.
• The impact of fixed costs on profit is emphasized.
• It is easier to estimate a product’s profitability.
• It ties in with cost control measures such as flexible budgets.
5.
a. Advantage of authoritative (top-down) budgeting: speed control.
Disadvantage of authoritative (top-down) budgeting: little buy-in, senior management has less
information than lower-level manager.
Advantage of participative (bottom-up) budgeting: more likely to commit
Disadvantage of participative (bottom-up) budgeting: may set easier targets
b. Best authoritative (top-down). Cost product most important, want to focus on control.
c. Benchmark with outside examples, mutual learning about problems, balanced scorecard method of
evaluation.
Case - 19
Barton Industries processes chemicals for the pharmaceutical industry. Wiley Richardson, company president, was
eager to see the operating results for the just completed fiscal year as he believed that changes that were made during
the year would result in increased profit on the expected sales volume of 1 million kg. At the beginning of the year, in
response to a 10% increase in production costs, the sales price had been increased 12%, and the selling and
administrative departments had been given strict instructions to hold expenses at the same level as the previous year.
Therefore, Richardson was dismayed to learn that net income had dropped despite achieving the planned increase in
sales volume. Shown below are comparative operating income statements for Barton Industries for the last two years
along with budgeted operating and financial data. This year’s cost of goods sold includes an adjustment of fixed
overhead costs that were under-applied. Actual results were the same as budget, except for production volume. The
company uses the first-in, first-out inventory valuation method, and has an ending inventory of 450,000 kg. this year.
Barton Industries
Comparative Operating Income Statements
($000 omitted)
Previous Year Current Year
Sales Revenue $9,000 $11,200
Cost of goods sold 6,600 8,815
Gross Profit $2,400 $2,385
Selling and administrative expense 1,500 1,500
Operating Income $900 $885
Barton Industries
Budgeted Operating and Financial Data
Previous Year Current Year

Sales price $10.00/kg. $11.20/kg.
Material cost 1.50/kg. 1.65/kg.
Direct labor cost 2.50/kg. 2.75/kg.
Variable overhead cost 1.00/kg. 1.10/kg.
Fixed overheard cost 3.00/kg. 3.30/kg.
Total fixed overhead costs $3,000,000 $3,300,000
Selling and administrative exp. $1,500,000 $1,500,000
Sales volume 900,000 kg. 1,000,000 kg.

Beginning inventory 300,000 kg. 600,000 kg.
Production volume 1,000,000 kg. 1,000,000 kg.
1. Explain why Barton Industries’ operating income decreased in the current fiscal year despite the sales price and
sales volume increases.
2. Prepare an operating income statement for the current fiscal year for Barton Industries using the variable
(direct) costing method.
3. Prepare a reconciliation of Barton’s operating income using the current method of absorption costing and using
the variable (direct) costing method.
4. Identify two advantages and two disadvantages of using variable (direct) costing for internal reporting.
Answer:
1. Production was less than budget, and fixed overhead cost were under-applied. This caused unfavorable
volume variance that was charged to cost of goods sold, increasing expenses and decreasing operating
income.
2. Barton’s operating income using variable costing (000 omitted):
Sales $11,200
Variable cost of goods sold:
600,000 units (inventory)@ $5.50 $3,000
400,000 units (production)@ $5.50 2,200 5,200
Contribution margin $6,000
Fixed cost of operations:
Factory overhead $3,300
Selling and administrative 1,500 $4,800
Operating income $1,200
3. Reconciliation:
OPERATING INCOME – VARIABLE COSTING $1,200

ADD: FIXED FACTORY OH EXPENSED UNDER VARIABLE COSTING 3,300
LESS: FOH ON 600,000 UNITS SOLD FROM BEGINNING OF INVENTORY

UNDER ABSORPTION COSTING: 600,000 * $3.00 1,800
LESS: FOH ON 4,00,00 UNITS SOLD FROM CURRENT PRODUCTION

UNDER ABSORPTION COSTING: 400,000 * $3.30 1,320
LESS: UNDER-APPLIED FIXED OH CHARGED TO COGS UNDER 495

ABSORPTION COSTING: (1,000,000 – 850,000) * $3.30
OPERATING INCOME – ABSORPTION COSTING $885
4. Advantages of variable costing for internal reporting:

• Aids in reporting and forecasting contribution margin.
• Because fixed cost are period costs, they are more predictable and controllable.
• Profits vary with directly sales volume and are unaffected by inventory changes.
• Aids CVP analysis/can determine breakeven point.
Disadvantages of using variable costing for internal reporting:
• Fixed cost may be overlooked as the part of the decision-making process.

• Lacks acceptability for external reporting.
• Cannot be used as a basis for income tax calculation.
• Sometimes distinction between fixed and variable cost is arbitrary.
Case - 20
Rosewood Designs produces customized textiles, such as dresses, formal attire, and uniforms. Rosewood is a small
sole proprietorship owned and managed by Samuel Wood. Rosewood uses a job order costing system. During July,
Rosewood completed Job 431, an order for 2,000 school uniforms. Based on the success of this large order, Wood is
contemplating a drastic change in business strategy. Wood is considering mass producing school uniforms and
gradually phasing out custom orders. Relevant financial information is shown below.
• Job 431 had a beginning work-in-process inventory balance of $33,000 on July 1.

• During July, $3,000 of direct material was added to the job. Job 431 required a total of 3,500 direct labor hours, with
1,000 of those hours taking place in July.
• The average labor rate for production workers is $7 per hour.
• Rosewood completed Job 431 on July 25.
• Rosewood's predetermined manufacturing overhead rate is $3 per direct labor hour.
• After completing Job 431, management analyzed the direct labor hours. Rosewood normally experiences an 80%
learning curve, and management expects that the learning curve will level off after producing 8,000 uniforms.

1. Define and explain the job costing system Rosewood currently uses.
2. Identify what costing system would be most suitable if Rosewood begins mass producing school uniforms.
Explain your answer.
3. For Job 431, calculate the cost per unit by using full absorption costing. Show your calculations.
4. Identify and explain the major difference between full absorption costing and direct costing.
5. Define and explain the concept of the learning curve.
6. After completing 8,000 uniforms, what is the estimated direct labor cost per uniform? Show your calculation
Answer:
1. Rosewood’s current job order costing system is used for custom, unique production where the costs of
each job can be traced directly to the unique order.
2. A job order system would not be adequate for costing in a mass production environment. When
producing large quantities of mass-produced homogenous products, the appropriate costing system is
process costing. This change is Rosewood’s business would completely change its costing system.
3.
Work in process beginning balance $33,000

Direct materials 3000
Direct labor 7,000 ($7 * 1,000 hours)
Manufacturing OH 3,000 ($3 * 1,000 hours)
Total job cost $46,000
$46,000/2,000 units= $23 per units
4. Variable costing in which the cost assigned to a product includes only the cost of inputs that vary directly
with the number of units produced. Only the directly variable product costs are charged to inventory,
such as direct materials, direct labor, and variable manufacturing overhead costs.
5. Learning curve is a mathematical expression of the phenomenon that incremental unit cost to produce
decrease as managers and labor gain experience from practice and as better methods are developed.
6. 80% learning curve

Units Cumulative avg. per Cumulative total hrs Time on most recent
unit
2,000 1.75* 3,500 hrs 3,500 hrs
4,000 1.40** 5,600 2,100
8,000 1.12*** 8,960 3,360
*3500 hours/2000 units = 1.75hours per unit

**1.75 × 80% = 1.4
***1.4 × 80% =1.12
8,960 – 5,600 = 3,360 hours spent on last 4,000 units
3,360 hours / 4,000 units = .84 hours per unit × $7 per hours = $5.88 direct labor budget per unit
Case - 21
Holt Manufacturing just completed its first year of operations. Holt produces a new type of computer accessory for
storing and charging laptop computers. Planning the production levels from month to month in this new business has
been a challenge. Managers and sales associates are making new business contacts and securing orders, but the sales
level each month can vary. The company is located in the state of Indiana in the U.S, and currently only sells to small
retailers in the Midwestern part of the U.S. The company’s sales force is working to identify new sales opportunities in
areas outside of the Midwest. Sydnee Wright is the sales manager for Holt Manufacturing. Wright believes that
projections for sales to increase over the next two to four years are accurate based on the planned expansion of the
company’s sales market. Olivia Radner is the production manager for the business. Radner is struggling to prepare
production forecasts based on the volatile sales levels in the new business. Production levels are determined using
forecasted sales data.
Following is a summary of the results for Holt’s first year of operations.
Sales $1,500,000
Unadjusted cost of goods sold 970,000
Selling and administrative expenses 528,000
Ending balances in the inventory accounts are shown below.
Raw materials $40,000

Work-in-process 22,000
Finished goods 14,500
Holt estimated overhead at the beginning of the year to be $300,000. Overhead is assigned based on machine hours,
which were estimated to be 48,000 for the year. Actual machine hours this year were 41,000. Actual overhead
incurred this year was $260,000.
1. Calculate the amount of Holt’s under applied or over applied overhead. Show your calculations.
2. Identify and describe two different methods Holt could use to allocate this under applied or over applied
overhead at the end of the year.
3. Identify and explain the most appropriate method to allocate this under applied or over applied overhead
in this situation.
4. Identify and explain the impact that the under applied or over applied overhead has on Holt’s profitability
for this year.
5. Explain how activity-based costing might help Holt in future years.
6. What type of budgeting could Holt use to monitor performance?

Answer:
1. Predetermined overhead rate = estimated total OH / estimated total allocation base
= $3,00,000/48,000 hours = $6.25 per hour
Applied OH = predetermine OH rate * actual number of hours
= $6.25 * 41,000 = $256,250
Actual OH $260,000 - $256,250 = $3,750 under applied
2. The two methods for allocating the balance of manufacturing overhead are pro-rata (also known as
proration) and writing off directly to cost of goods sold. Under proration, the under or over allocated overhead
is allocated between the ending balances of work
-in process inventory, finished goods inventory and cost of goods sold on a pro-rata basis using ending
balances. The final balance of manufacturing overhead is zero after the entire amount is transferred
proportionately to these accounts. Note you do NOT include raw materials in the allocation since no overhead
is assigned to raw materials inventory. Under the write off to cost of goods sold method, the total of the under
or over applied overhead is all transferred to cost of goods sold.
3. Selection of the method to use should be based on management’s knowledge of what caused the under or
over allocation during the period. Materiality should also be considered. In Holt’s case, the under applied
overhead is $3,750, a relatively small amount compared to the size of the operations ($1,500,000 sales). The
company maintains relatively small levels of inventory compared to the cost of goods sold (Work in process
of $22,000; Finishedgoods$14,500 compared to unadjusted cost of goods sold $970,000). Holt should allocate
the under applied overhead directly to cost of goods sold.
4. Preliminary results prior to adjusting for the under/over applied overhead show the company as profitable
for the first year. Sales $1,500,000 –unadjusted cost of goods sold $970,000 –selling and administrative
$528,000 = net income $2,000. In
closing out the under applied overhead directly to cost of goods sold, it will increase (debit) cost of goods sold.
The closing entry will credit manufacturing overhead. By increasing cost of goods sold, the net income
(profitability) of the company decreases. In this case, while the adjustment is small, it is enough to move the
company from a net income to net loss. After adjustment, the company’s results will be:
Sales $1,500,000
- Cost of goods sold (973,750)
- Selling & administrative expenses (528,000)
- Net loss ($1,750)
5. Activity based costing (ABC) refines a costing system by identifying individual activities as the fundamental
cost objects (Horngren 146). Holt would be able to identify cost objects and various cost pools for overhead.
Using ABC, Holt could refine and improve their cost analysis by using different cost pools and different cost
drivers for various overhead activities. ABC cost drivers have a better cause and effect relationship with costs
in the cost pool (Horngren 154). ABC provides a more accurate costing that will provide better information for
decision making. The cost-benefit of ABC should be considered as the cost of implementing such a system can
be significant. If machine hours truly drive most of the overhead costs or Holt produces only one product, ABC
might not be beneficial.
6. The key to monitoring the business’s performance with budgets will be to use flexible budgeting. As activity
levels could change and vary from the original master budget plans, Holt should use flexible budgeting to
compare actual results to a budget based on actual production levels. “Managers can use the flexible budget
as part of the planning process to predict how the budget will change under various
scenarios, such as a “worst case” or “best case” scenario. They can also use the flexible budget as a benchmark
for evaluating performance after the fact, or as part of the control process.”
Case - 22
Arklan Production is upgrading its manufacturing process from a manual process to a highly automated system.
Management believes that the new system will result in greater efficiencies and a better finished product. Arklan is also
working on a plan to downsize staff after the implementation of the new system. Arklan has used a traditional
absorption costing system to calculate unit product costs for external financial reporting. In the past, Arklan has
allocated its manufacturing overhead costs using a predetermined plant-wide overhead rate based on direct labor
hours. The controller realizes that the new system may require changing the overhead allocation process. Management
plans to take the opportunity to reconsider other improvements to the costing system.
1. Identify and explain three disadvantages of using a predetermined plant-wide overhead rate to allocate
overhead costs.
2. Identify and explain three benefits of using departmental overhead rates to allocate overhead costs.
3. Explain why direct labor hours may not be a good basis for allocation of overhead costs after Arklan
implements the new system.
4. Recommend two bases of overhead allocation other than direct labor costs that might work better in the
new manufacturing process. Explain your recommendation.
5. Identify and explain two differences between a traditional cost allocation system and an activity-based
costing (ABC) system.
6. Explain the difference between absorption costing and variable costing. Identify which is more suitable for
internal decision making and explain.
7. Identify and explain two limitations of an ABC system.

Answer:
1. A plant wide allocation system may work well for some companies but may end up distorting product costs
if different departments incur different amounts of manufacturing overhead or if different products use
departments to a different extent. When either or both of these conditions exist, the plant wide overhead
rate will likely distort product costs, allocating higher than actual costs to departments that do not incur
certain costs and higher than actual costs to products that do not use all departments as part of production.
It usually does not provide valuable information to the cost control and improvement of internal controls. It
can hardly motivate department managers to achieve goals of top management, then fairly determine the
rewards earned by the managers.
2. A departmental overhead rate does a better job of matching each department’s overhead costs to the
products that use the department’s resources. It provides more valuable information to the cost control and
improvement of internal controls.
It also provides the right incentive for managers to make decisions that are consistent with the top
management and evaluate their performance fairly.
3. The old manufacturing system was highly manual and direct labor hours were directly related to the actual
work that put into each product. Since the new system is automated, there will be significantly less direct
labor hours and the hours may not reflect the true costs of the product.
4. Two potential bases for overhead allocation are machine hours and production units through each
department. If all products through a department require machine hours, this may be a good base for
allocation. If throughput units use departmental resources equally, this maybe a good base.
5. Activity-based costing systems focus on activities rather than on departments. Costs are allocated to products
based on the activities that are required to complete each product. In ABC, nonmanufacturing as well as
manufacturing costs may be assigned to products and some manufacturing costs may not be included in
product costs. For example, costs related to sales, distribution and servicing products may be included in
product costs while costs that are not affected by which products are made will not be allocated. Traditional
cost allocation usually picks one or two predetermined plant-wide overhead rates to allocate overhead costs.
6. Absorption costing includes both variable and fixed manufacturing expenses while variable costing only
includes variable manufacturing costs. Variable costing treats fixed manufacturing costs as period costs.
Variable costing is more suitable for internal decision making since in the short run, fixed manufacturing costs
are out of the control of management. Focusing on variable costs can help them decrease wastes, improve
efficiency and increase profit. Also using variable costing for internal decision making can prevent
management from manipulating income by simply increasing inventory levels.
7. Beginning an ABC system requires significant resources and must be routinely maintained to keep the data
driving the system current. Additionally, the ABC system will not agree with financial numbers produced by
the traditional costing system and, thus may be questioned by department managers, sales personnel and
management who are used to the old system. If a company’s products do not differ significantly in the
resources used, the additional costs of ABC may not be worth the additional costs.
Section E - Internal Controls
Case- 23
Ted Crosby owns Standard Lock Inc., a small business that manufactures metal door handles and door locks. When he
first started the company, Crosby managed the business by himself, overseeing purchasing and production, as well as
maintaining the financial records. The only employees he hired were production workers.
As the business expanded, Crosby decided to hire John Smith as the company’s financial manager. Smith had an MBA
and ten years of experience in the finance department of a large company. During the interview, Smith mentioned that
he was considering an offer from another company and needed to know of Crosby’s decision within the next couple of
days. Since Crosby was extremely impressed with Smith’s credentials, he offered him the job without conducting
background checks. Smith seemed to be a dedicated and hard-working employee. His apparent integrity quickly earned
him a reputation as an outstanding and trusted manager.
Later in the year, Crosby hired another manager, Joe Fletcher, to oversee the production department. Crosby continued
to take care of purchasing and authorized all payments. Fletcher was highly qualified for the position and seemed to be
reliable and conscientious. After observing Fletcher’s work for one year, Crosby concluded that he was performing his
duties efficiently. Crosby believed that Fletcher and Smith were both good managers whom he could trust and gave
them expanded responsibilities. Fletcher’s additional responsibilities included purchasing and receiving; Smith paid all
the bills, prepared and signed all checks, maintained records, and reconciled the bank statements.
Soon Crosby began taking a hands-off approach to managing his business. He frequently took long vacations with his
family and was not often at the office to check on the business. He was pleased that the company was profitable and
expected that it would continue to be profitable in the future under the supervision of two qualified and trusted
managers. One year after Crosby left the management of the company to Smith and Fletcher, business began to
experience a decline in profits. Crosby assumed that it was due to a cyclical downturn in the economy. When Standard
continued to decline even as the economy improved, Crosby began to investigate. He noticed that revenues were
increasing but profits were declining. He also discovered that purchases from one vendor had increased significantly as
compared to the other five vendors. Crosby is concerned that fraud may be occurring in the company.
1. Identify and describe four internal control deficiencies within Standard Lock Inc.
2. For each of the internal control deficiencies identified, recommend an improvement in procedures that
would mitigate these deficiencies.
3. If the company were to implement an ideal internal control system, can it guarantee that fraud would not
occur in future? Explain your answer.
Answer:
1. Four internal control deficiencies with standard lock Inc. are:

a. Crosby, the owner, is taking a hands-off approach. He is hardly around to check on the business.
b. The managers Smith and Fletcher have too much control without any independent checks on them.
c. Hiring policies to hire the right kind of employees are lacking; Crosby does not screen the job
applicants; he did not check any background references for Smith and Fletcher.

d. Proper internal controls such as segregation of duties, authorization, independent checks are not in
place. Fletcher places purchases order, and also receives materials. Smith is in charge of collecting the
payments, maintaining records, reconciling the back accounts, preparing and signing checks, and
approving payments. Lack of basic internal control seems to have opened the door for employees to
commit fraud.
2. Proper internal control must be In place so that opportunities to commit, and/or conceal fraud are
eliminated. In this case, the internal controls needed are:
a. Segregation of duties
b. System of authorizations
c. Independent checks
d. Proper documentation.
No one department or individual should handle all aspects of transaction from beginning to end. No one
person should perform more than one functions recording transaction, and reconciling bank accounts (as
done by Crosby in this case). In as similar manner, Fletcher should not authorize purchases, receive
inventory and issue materials for production. The company should also separate the duties of preparing
and signing checks, especially because the same period has the authority to approve payment.
There is a failure to enforce authorization control. Crosby should authorize purchases and approve
payments. He might consider hiring another person so that the two tasks, record keeping and bank
reconciliation can be separated.
In addition to that, the company must have better hiring policies in place, that may require vacations,
conduct internal audits and have good oversight over employees.
Require vacations conduct internal audits, owner/board oversight.
3. Even the best internal controls do not guarantee that fraud will be eliminated. These controls provide
reasonable, not absolute, assurance against fraud. Internal control is not fraud proof; internal control
never provides absolute insurance that fraud will be prevented. Effectiveness depends on competency
and dependability of people enforcing the controls.
Case - 24
Ace Contractors is a large regional general contractor. As the company grew, Eddie Li was hired as the controller and
tasked with analyzing the monthly income statements and reconciling all of the accounts formerly handled by Susan
Zhao, the sole accounting associate. Li noticed a large amount of demolition expense for February, even though no new
projects had started over the past few months. Since Li did not expect such a large amount of demolition expense, nor
was any of this type of expense budgeted, Li dug a little deeper. He found that all of those expenses were bank transfers
into another bank account. After additional research, it became evident that Zhao had been transferring funds out of
the company bank account and into her own, and recording fake expenses to make the bank account reconciliation
work. While the president kept the pre-numbered checks locked up until check run time and signed all of the outgoing
checks, he was unaware of the ability to initiate transfers via the internet. Li had also reviewed the bank reconciliations,
which were completed by the office manager, and this fraud was not evident since the ending balance was reasonable.
1.
• Identify and explain the four types of functional responsibilities that should be segregated properly.
• Identify and explain two incompatible duties that Zhao had that allowed her to take company funds.
2. Identify and explain two ways that the company had attempted to safeguard its assets and suggest two ways
to strengthen controls in this area.
3. Refer to COSO’s Internal Control Framework to answer the following questions.

• Identify and describe the three objectives of internal control.
• Identify and describe five components of internal controls.
4. Identify and explain three ways internal controls provide reasonable assurance.
Answer:
1.
a. Four types of functional responsibilities that should performed by different people
• Authority to execute transactions
• Recording transactions
• Custody of assets and
• Periodic reconciliation
b. Which incompatible duties did Zhao Have?

Zhao could execute transaction by initiating a transfer and could record transactions by entering the
joint venture that was erroneous.
2. Attempted controls:
• The company had physical controls over their checks
• The president authorized and signed all checks
• The maintained pre-numbered check stock.
• The company had a prepared budget to compare to actuals to identify variances
Way to strengthen:
• Restrict fund on-line transfer ability.

• Randomly select audit expenses transactions on a periodic basis
• Separate the incompatible duties
3.
a. The three internal control objective are
• Operation objectives: operations should be as efficient as possible; the company’s
resources should be used effectively and efficiently. Assets should be safeguarded against
loss.

• Reporting objectives: internal and external financial and non-financial reporting objectives
includes reliability, timeliness, transparency, and other requirements of regulators, standard
setters, or the entity’s policies.
• Compliance objective: care should be taken to follow and be in compliance with all
applicable laws and regulations to which the company is subject.
b. The five components of internal control are:

1. Control environment- the board of directors and senior management set the tone of an
organization, influencing the control consciousness of its people and establishing expected
standards of conduct that apply to all employees.
2. Risk assessment – identifying and analyzing and managing risks that have the potential to
prevent the organization from achieving its objectives.
3. Control activities – Action established by policies and procedures that help ensure that
management directives that are intended to limit risks to the achievement of the organization’s
objectives are carried out.
4. Information and communication- identifying, capturing and communicating relevant
information that enables people to carry out the internal control responsibilities that support
achievement of the organization’s objectives.
5. Monitoring – Assessing the quality of the internal control system’s performance over time to
determine whether the components of internal control are present and functioning,
4. Describe three ways internal controls are designed to provide reasonable assurance.
• Segregation of duties – assigning different employees to perform functions
• Reconciliation of recorded accountability with assets
• Safeguarding controls- limit access to an organization’s assets to authorized personnel.
Case - 25
Michael Hanson is an internal auditor who has been asked to evaluate the internal controls and risks of his company,
Consolidated Enterprises Inc. He has been asked to present recommendations to senior management with respect to
Consolidated’s general operations with particular attention to the company’s database procedures. With regard to
database procedures, he was specifically directed to focus attention on (1) transaction processing, (2) virus protection,
(3) backup controls, and (4) disaster recovery controls.
1. For each of the areas shown below, identify two controls that Hanson should review and explain why.
• Transaction processing
• Virus protection.
• Backup controls.
2. Identify four components of a sound disaster recovery plan.
3. During his evaluation of general operations, Hanson found the following conditions.
• Daily bank deposits do not always correspond with cash receipts.
• Physical inventory counts sometimes differ from perpetual inventory records, and there have been
alterations to physical counts and perpetual records.
• An unexplained and unexpected decrease in gross profit percentage has occurred.
For each of these conditions, (1) describe a possible cause of the condition and (2) recommend
actions to be taken and/or controls to be implemented that would correct the condition.
Answer:
1.
a. The objective of a compliance audit is to determine to what degree the organization is operating in
conformance with established laws, standards, and procedure.
b. The objective of an operational audit is to appraise the systems of internal control and the overall
efficiency and economy of operations and the effectiveness with which those functions achieve their
objectives.
2.
a. Transaction processing controls include: passwords to limit access to input or change data,
segregation of duties to safeguard assets, control totals to ensure data accuracy.
b. Virus protection controls include: ensuring that latest edition of anti-virus software if installed and
updated, firewalls set up to deter incoming risks, limit internet access to business-related purposes to
reduce chance of viruses.
c. Backup controls include identification of vital systems to be backed up regularly, development of a

disaster recovery plan, testing of backup communications and resources.
3. A sound disaster recovery plan contains the following components:

• Establish priorities for recovery process
• Identification of software and hardware needed for critical process identity all data files and
program files required for recovery
• Store files in off-site storage
• Identify who has responsibility for various activities, which activities are needed first
• Set up and check arrangements for backup facilities
• Test and review recovery plan
4.
a. Bank deposits do no always correspond with cash receipts. Possible cause: cash received after the bac
deposit has been made. Action: have a separate individual reconcile incoming cash receipts to back
deposits.

b. Physical inventory counts sometimes differ from perpetual inventory records, and sometimes there
have been alterations to physical counts and perpetual records. Possible cause: timing differences.
Action: limit access to physical inventory, require and document specific approvals for adjustment to
records.
c. Unexpected and unexplained decrease in gross profit percentage has occurred. Possible cause:
unauthorized discounts or credit provided to customers. Actions: establish policies for discounts and
credits, document approvals.
Case - 26
AccuBrake Inc., a manufacturer of lifts for auto service shops, purchases their supplies both domestically and
internationally. Robert Hwang, the chief audit executive, was preparing for year-end meetings with the Board of
Directors and senior management. He had recently become aware of a conflict of interest between the purchasing
manager of the company and the company’s largest domestic supplier where it appeared that the company had
materially overpaid for some of its supplies. He planned to report this conflict to the Board. He found no issues in the
review of the international suppliers, but he did identify an issue with the warehouse. He found that the finished
inventory in the warehouse was not appropriately safeguarded. As part of the year end meeting, Hwang planned to
request that the chairman of the board sign off on the appropriateness of the financial statements to be compliant with
the Sarbanes-Oxley Act.
1. Identify and describe two types of internal control failures and related risks that internal auditors should
report to management or to the Board of Directors.
2. Should the chief audit executive report the conflict of interest to the Board of Directors? Explain your answer.
3. Identify and explain four responsibilities of the Board of Directors’ with respect to ensuring that the company
is operated in the best interest of shareholders.
4. Describe three activities relating to auditors prohibited under Section 201 of the Sarbanes- Oxley Act Section
201 relating to auditors’ activities.
5. Will the company be compliant with the Sarbanes-Oxley Act Section 302, if the chairman signs off on the
appropriateness of the financial statements? Explain your answer.
6. Identify and describe the major internal control provisions of the Foreign Corrupt Practices Act (FCPA).
7. Identify one change that the management of AccuBrake should implement to be compliant with the FCPA.
Answer:
1. Reporting should include significant risk exposures and control issues, corporate governance issues,
and other matters needed or requested by the Board and senior management. The report should
highlight significant engagement observations and recommendations. Significant engagement
observation are those conditions that in the judgement of the chief audit executive, could adversely
affect the organization. Significant engagement observations may include conditions dealing with
irregularities, illegal acts, error, inefficiency, waste, ineffectiveness, conflicts of interest, and control
weaknesses. After reviewing such conditions with senior management, the chief audit executive
should communicate significant engagement observations and recommendations to the board.
2. Yes, the audit executive should report the conflict of interest since it is a conflict of interest and
resulting in material overpayments.
3. The Board of Directors’ responsibilities include the following:
• To be a review organ – without such an organ, top management has no way to control itself.
• To remove top management when its fails to perform. A board capable of removing non-
performing top management has real power.
• To be a public relations and community relation organ. The board needs easy and direct
access to the various publics and constituents.
• To develop policy and implement procedures necessary to limit conflicts of interest and to
ensure compliance with both the law and ethical principal at all levels of enterprise.
• To ensure that the corporate compliance program is in place.
The board is obligated to exercise a good faith judgement that the corporation’s information and
reporting system is, in concept and design adequate to assure that appropriate information will come to
its attention in a timely manner as a matter of ordinary operations. Will act on an informed basis, in
good faith, and in the honest belief that the action taken was in the best interest of the company.
4. Section 201
Service Outside the Scope of Practice of Auditors- Prohibited Activities
An accounting firm providing audit services to a client can’t perform any of the following:
o Bookkeeping or other service related to the accounting records of financial statements.
o Financial information systems design and implementation
o Appraisal or valuation services, fairness opinions, or contribution-in-kind reports
o Actuarial services
o Internal audit outsourcing services
o Management functions or human resources
o Broker or dealer, investment advisor, or investment banking services
o Legal services and expert services unrelated to the audit
o Any other service determined by the Public Company Accounting Oversight as unallowable.
5. Section 302: Corporate Responsibility for Financial Reports

The CEO and CFO of each public company issuing financial reports must prepare a statement that
accompanies that audit report to certify the appropriateness of the financial statements and
disclosures contained in the period report and that those financial statement and disclosures fairly
present, in al material respects the operations and financial condition of the issuer. The CEO and EFO
must knowingly and intentionally violate this requirement in order to be liable.

The company will not be complaint if the chairman of the board signs off on the financial statements
since Sarbanes-Oxley requires the CEO and EFO to make this certification, not the Chairman of the
Board.
6. The act in general says that internal accounting controls shall be examined and if material Weaknesses
are found, controls must be strengthened, or additional ones installed. Bribes or questionable conduct
shall cease, and funds for such bribes and conduct must not be made available. The controls part
requires that companies shall:
a. Make and keep books, records and accounts which in reasonable detail, accurately and fairly
reflect the transition and dispositions of the assets of the issuer and
b. Devise and maintain a system of internal accounting controls sufficient to provide reasonable
assurance that
i. Transactions are executed in accordance with management’s general or specific
authorization and
ii. Transaction are recorded as necessary to (1) permit preparation of financial statement
in conformity with generally accepted accounting principles or any other criteria
applicable to such statement and (2) to maintain accountability for assets
iii. Access to assets is permitted only in accordance with managements general or specific
authorization and
iv. The recorded accountability for assets is compared with the existing assets at
reasonable intervals and appropriate action is taken with respect to any difference
The act gives management and internal auditors a wider concern: decision and maintaining a
system of internal accounting controls to provide reasonable assurance that transactions are
authorized and accounted for and that assets are safeguarded.
7. In this scenario, the chief audit executive found that the inventory was not properly safeguarded, and
they need to add additional procedures to ensure that their assets are properly safeguarded. In
addition, they should add some additional authorizations or other procedures to prevent the
overpayment and conflict of internet for the supplies.
Case - 27
Acme has retail clothing stores in the United States and Europe that transmit daily sales data to the corporate office to
be posted in the general ledger. Each day, the store sales team enter the sales transactions as well as customer credit
card payments into the sales system. The system will alert the user if a negative cost or an invalid stock number has
been entered. At the end of the day, a batch total is created. The system summarizes the information to send and the
batch total is checked again to ensure that it is still the same. The files are then encrypted and transmitted to the
corporate office via the internet. The receiver of the information checks the batch total before uploading the
information to the general ledger and then sends the store a summary report of the activity received. The servers that
house the general ledger system are kept in the basement of the corporate office in a locked room. They limit access
to the information to authorized users and maintain records of all usage. The desktops used for receiving the
transmissions are password protected.
1. Explain input controls, processing controls, and output controls and identify one each in this scenario.
2. Define data encryption and describe why there is a much greater need for data encryption methods when
using the internet.
3. Identify two procedures that Acme could implement to better limit access to its physical hardware.
4. Identify two ways that Acme could limit access to its data and computer programs to authorized users.
5. How can separation of duties enhance systems security?
6. Identify two accounting system duties that should be kept separate to improve internal controls.
Answer:
1. These controls are all application controls and they are necessary to prevent, detect, and correct errors
and irregularities in processing transactions.
Input controls are application controls over data input. Input controls help ensure the validity accuracy,
and completeness of the data entered into an accounting information system. It is usually cost effective
to test input data for the attributes of validity, accuracy, and completeness as early as possible. Data that
is rejected at time of input can be corrected more easily, and it is not cost effective to screen data
throughout the process. Input controls help assure that what is received by the machine is complete. Each
entry can have checked to make sure that the fields are filled out properly and for reasonableness or logic.
Input controls help with inaccurate recording of input and preventing missing information.
Processing controls are application controls that are intended to protect the processing of data. The
purpose is to prevent, detect and correct errors and irregularities in processing transactions. Processing
controls have been designed to prevent or discourage the improper manipulation of data and to ensure
the continued satisfactory operating of the hardware and software. Processing controls prevent duplicate
data and the loss of files during processing, processing performed too late, or incomplete processing.
Processing controls focus on the manipulation of accounting data after they are input. An important
objective of processing controls is to contribute to a good audit trail.
Output controls cover the accuracy and reasonableness of the information processed. They also cover the
retention of output reports. The total records processed can agree with the records input. Pre-numbered
forms can help control output since these can be accounted for. Output controls ensure the outputs’
validity, accuracy and completeness. Two main types of output controls are validating processing results
and regulating the distribution and use of printed output.
In the scenario, there are input controls when the store sales team enters the individual sales into the
sales system. The system will alert the user if a negative cost or if an invalid stock number has been
entered. There is a processing control with the batch totals that are created and checked. There is an
output control with the final batch check and the sending of the activity report.
2. Date encryption is scrambling the data in a message in a systematic way in order to prevent competitors
from electronically monitoring confidential data transmissions. Through an encryption technique, data is
converted into a scrambled format prior to its transmission and converted by into a meaning form once
data transmission is finished. The encrypted data can be read only by a person with a matching decryption
key.

Data encryption is particularly important when using the internet as the routine use of systems include
potential unauthorized access to computer systems and its data through electronic eavesdropping, which
allows computer users to observe transmissions intended for someone else, or cause errors in data
transmission. Managers use data encryption to protect information.
3. Access to the physical hardware must be protected and could be in a safer location than the company’s
basement. Data processing centers should be located in safe places away from scrutiny and guarded by
personnel. The location should consider natural disasters and should limit employee access. Few people
have reason to be inside and access should be limited to company personnel who wear badges with
pictures. Employees entries and exists should be logged and interior room should be protected with
mechanism that requires people to be buzzed in to enter. Also, issue keys to authorized personnel only
and change locks periodically. For individual computers, the passwords are good, but they should ensure
they are using strong passwords. Consider the use of biometric identification.
4. To better protect its programs and databases from unauthorized use, the company should consider logical
security controls. These controls include e-IDs and passwords, system authentication requirements,
biometrics, logs of log-on attempts, application level firewalls, antivirus and antispyware software,
intrusion detection systems, encryption for data in transits, or smartcards.
5. Highly integrated accounting information systems often combine procedures that used to be performed
by separate individuals. Consequently, an individual who has unlimited access to the computer, its
programs, and live data also has the opportunity to execute and subsequently conceal a fraud. To reduce
this risk, a company should design and implement effective separation of duties control procedures. It is
essential to divide the authority and responsibility for these two functions. The design and
implementation of effective separation of duties control procedures make it difficult for any one
employee to commit a successful fraudulent activity.
6. Accounting systems duties that should be kept separate include:

The data control group should review records for evidence of unauthorized computer access.
- Computer operators should not have access to program documentation or logic.
- Two operators should be in the computer room during processing of data,
- Maintain a processing log and review periodically for evidence of irregularities.
- Rotate computer operators among jobs to avoid any singles operator always overseeing the
same application.
- Require formal authorizations for program changes, submit written description of changes to a
supervising manager for approval.
- Test changes to programs prior to implementation.
- A data control group should maintain registers of computer access codes, help acquire new
accounting software, coordinate security controls with specific computer personal, reconcile
input and output and distribute output to authorized user. This person should be independent
of computer operation which inhibits unauthorized access to computer facility and contributes
to more efficient data presenting authorizations.
Case - 28
The headquarters of Greeting Card Stores Inc. is located near a large river that flooded after an extremely heavy rainfall.
The disaster recovery leader had recently left the company, and a new person had not yet been named, nor had the
plan been tested for some time. The company has a backup location for all systems, but it is in the same area and was
subject to the same flood. The backup files were in the basement and first floor of the backup location. Some files were
salvaged but do not have clear descriptions, and management is not sure if they are the correct files. After two days of
being unable to process the store sales, management has implemented a backup system. This system allows them to
process sales, but it does not have all of the current data, so some large sales that were in process were lost.
1. Explain the objective of a disaster recovery plan.

2. Explain the importance of backing up all program and data files regularly and storing them at a secure remote
site.
3. Explain the difference between a hot backup site and a cold backup site.
4. Recommend four changes to improve the disaster recovery and storage control procedures at Greeting Card
Stores Inc.
5. Besides disaster recovery, system security is also an important control to the business. Identify three means
by which management can protect programs and databases from unauthorized use.
Answer:
1. The objective of a disaster recovery plan is to ensure that a company will be able to operate despite any
interruptions such as power failures, system crashes, natural disasters, etc. It is a process and set of
procedures that organizations follow to resume business after a disruptive event. Important components
include:
• Disaster recovery team, including a primary leader and an alternate leader.
• Designation of a specific backup site to use for alternate computer processing i.e. hot site or cold
site.
• Test, document and update the plan as required. Review the plan continuously.
• Also include backups for hardware.
2. The regular backup and proper storage of program and data files will reduce financial risk and business
risk. Misstatements might arise if data is lost due to inadequate backing up. Loss of data can also cause
severe interruptions of business operations and loss of income.
3. A hot site is fully operational and can come online more or less immediately. A flying-start hot site has the
latest data and software, so it can switch on in only a few seconds after the main site goes down.
cold site is basically a bare facility, where hardware can be installed relatively quickly (days not minutes).
A warm site is somewhere in between, with some communications and networking capabilities, but
requiring some hardware / software installation.
The choice of the level of backup site preparedness is based on the company’s weighing the cost of being
offline (lost sales, etc.) versus the cost of buying / maintaining the level of backup.
4. Greeting Cards can improve the disaster recovery and storage control procedure by:

• ensure a disaster recovery leader is named
• test backup plan regularly to ensure that it is working.
• keep backups in a location that might not be subject to the same natural disasters.
• keep several sets of backups in case the most recent one can’t be used.
• use better file labeling storage controls. External file labels or internal file labels.
5. Means that management can use to protect programs and databases from unauthorized use include:
Facility and hardware controls: Control access to the building, locate data center away from public areas,
give access to only authorized personnel, use key codes or biometrics for entrance, etc.
Network controls: Use private network or use virtual private networks to secure connection to Internet,
add password protection and require periodic password change, encrypt data before data transmission,
ensure correct destination address by routing verification, verify message delivery via message
acknowledgement, detect and defend attacks through virus protection software and firewall, alert
intrusion by intrusion detection system, etc.
Case - 29
Soba Kelly oversees the payroll process at Logan Associates which has 20 hourly employees. The company is small, and
Kelly is the only employee allowed to use the payroll system. Each pay period, Kelly must add or change employee
information and then she runs the pay-cycle. Kelly enters the hours for each employee, and the computer system checks
that she has entered a reasonable number of hours for each person (e.g., no negative hours, no hours over a certain
threshold).
After Kelly has entered all the data, a control total is generated; this control total shows the total number of hours,
which she can confirm by checking to the total from the time clock. After the payroll checks are printed, she obtains a
summary report showing the total payroll dollars and total number of employees paid. Kelly confirms that the number
of checks printed, and the overall amount paid are reasonable. She also confirms that the pre-numbered checks agree
to the check numbers that the computer has assigned to each of the transactions.
1. Describe the purposes of input controls, processing controls, and output controls.
2. Provide one example of an input control, a processing control, and an output control at Logan Associates,
respectively.
3. Identify and explain three ways by which Logan’s management can protect programs such as the payroll
system from unauthorized use.
4. Identify three ways that Logan Associates can ensure that limited access to physical hardware can be
achieved.
5. How can Logan Associates ensure that access to the blank checks has been safeguarded?
6. Describe two ways that additional segregation of duties at Logan Associates could enhance the security of
the payroll process.
Answer:
1. Input controls help ensure the validity, accuracy, and completeness of the data entered into an
accounting information system.
Processing controls focus on the manipulation of accounting data after they are input to the
computer system. They contribute to a good audit trail.
Output controls ensure the outputs’ validity, accuracy and completeness.

They validate processing results and regulate the distribution and use of printed output.
2. Input -the computer system checks that the has entered a reasonable number of hours for each
person (i.e. no negative hours, no hours over a certain threshold).
Processing -After she has entered everything, she gets a control total that shows her the total
number of hours, which she can confirm by checking to the total from the time clock.
Output -After the payroll checks are printed, she gets a summary report showing the total payroll
dollars and total associates paid. She can confirm that the number of checks printed and that the
overall amount is reasonable, and she also confirms that the pre-numbered checks agree to the
check numbers that the computer has assigned to each of the transactions.
3. Management can protect programs such as the payroll system described above from unauthorized
use by the following:
• Facility monitoring (surveillance systems, cameras, guards, exterior lighting
• Access controls to facilities/datacenter or computer (biometrics, access cards)
• Alarm systems (fire, burglar, water, humidly, power fluctuations)
• Shred sensitive documents
• Proper storage and disposal of hard drive and other electronic storage media
• Secure storage of backup copies of data and master copies of critical software.
4. Management should also ensure that access to physical hardware is limited, using the following:
• e-ids and passwords
• system authentication
• biometrics
• logs of log on attempts
• application level firewalls
• anti-virus and anti-spyware software
• intrusion detection systems
• encryption for data it transit
• smartcards

5. check should keep the blank checks in a locked, fireproof safe.
6. Kelly currently authorize record transactions (authority), cut the checks (custody), and records the
payroll entries (records). The scenario does not mention who does the reconciliation. Kelly could add
a fake employee and pay herself or give herself a raise. It would be better if there was a separate
approval process for additions or changes to the payroll data and if there were someone else in charge
of the checks. A separate person should oversee related reconciliations, if possible.
Section F - Technology tics
Section F – Technology and Analytics
Case - 30.
Wolfe’s Supply is a small company that sells high-end bathroom fixtures and plumbing supplies with a centralized office,
warehouse, and in-house server. The small IT department is led by Ian, who is experienced and capable, but short-
handed for maintaining all of the company’s technology.
One Monday morning, the first employees into the office logged in and were greeted with a message that the contents
of their computers had been encrypted along with a demand for 10 bitcoin to access the files. The IT staff also quickly
discovered that the server’s data was encrypted, essentially shutting down the entire company.
Ian began figuring out what happened and realized that an unpatched exploit in his operating system was used to
retrieve passwords that were improperly stored in plain text, and then the attacker logged in to Ian’s account. Because
Ian was responsible for maintaining all of Wolfe’s PCs, his account also had access to all of the employees’ computers.
1. What are the two main defenses against ransomware?

2. Explain how encryption works, and why Wolfe cannot access the encrypted data again without paying the
ransom.
3. What is bitcoin?
4. What is two-factor authentication and how might it have prevented this type of attack?
5. How could Software as a Service mitigate the damage caused by ransomware?
6. Discuss and outline the major elements of a data backup plan.
Answer:
1. The two main defenses against ransomware are to avoid installing it in the first place a having full data
backups that can be used to restore
The data.
2. Encryption converts data into an unreadable code with a specific key required to convert the code back
into readable data. Because Wolfe’s data was encrypted using a key known only to the attacker, the
encrypted data cannot be recovered without paying for the key.
3. Bitcoin is a cryptocurrency that uses a distributed ledger.
4. Two factor authentication requires two independent, simultaneous actions before granting access to a
system. Such actions are broken into three categories: something you know, something you are, and
something you have. If another form of authentication had been required, such as a biometric scan or a
code from an electronic fob, a remote login would not have been possible.
5. Software as a Service is a type of cloud computing software developed for use by multiple businesses, and
both the software and the data are stored in the cloud and accessed via a web browser. Because data is
stored in the cloud, a ransomware attack on Wolfe’s PCs would not affect the company’s data. Additionally,
Wolfe would not need to maintain their own server when using a Software as a Service platform.
6. The major elements of a data backup plan include:
• Program files and data should be backed up regularly.

• Backups should be stored in a secure, remote location, or on the Cloud.
• For transactional systems, a transaction log should be used so that recent
transactions can be re - applied to the most recent data backup in the event of a failure.
• The backups should be tested regularly to ensure that they are accessible,
complete, and usable.

Essay Part 1

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Essay Part 1

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2020 -

Essay Question and

1|CMA US (Part I) Complied By: Prof. Ravi Gupta

Preliminary Management Response

2|Essay Question and Answer s Sheet

The negative behavioral impacts may include

3|CMA US (Part I) Complied By: Prof. Ravi Gupta

Building $10.0 million

5. Identify and explain three characteristics of a successful budgeting process.

4|Essay Question and Answer s Sheet

Budgeted sales (in units) = 10,000

5|CMA US (Part I) Complied By: Prof. Ravi Gupta

1. Describe the role budgeting plays in strategic planning.

6|Essay Question and Answer s Sheet

Anticipated toy sales in units

7|CMA US (Part I) Complied By: Prof. Ravi Gupta

1. Characteristics that define successful budgeting processes include:

8|Essay Question and Answer s Sheet

2. The sales budget should consider:

9|CMA US (Part I) Complied By: Prof. Ravi Gupta

7. Excess inventory impacts financials in the following ways:

• Consuming large warehouse space.

Section C - Performance Management

a. . Define budgetary slack.

11 | C M A U S ( P a r t I ) Complied By: Prof. Ravi Gupta

1. First unit: 500 hours.

2. $25*500 hours* 4units = $50,000 cost with no learning curve.

2. Direct labor efficiency variance (AQ – SQ) * SP

13 | C M A U S ( P a r t I ) Complied By: Prof. Ravi Gupta

a. . Calculate the variable expense variance. Show your calculations.

3. 5,700 * $275 = $1,567,500 actual revenue

Actual Budget Variance

Direct material 23,10 20,000 3,100U

Indirect labor 9,400 6,000 3,400U

Marketing expense 8,300 7,000 1,300U

Operating profit $ 11,300 $ 12,450 $ 1,150U

15 | C M A U S ( P a r t I ) Complied By: Prof. Ravi Gupta

2. To improve the monthly performance report, Woodcrafts Inc. should:

PRESSER DIVISION OPERATING STATEMENT

1)Return on investment (ROI).

A. ROI = operating income of business unit divided by assets of business unit

RI = $2,460,000 – ($12,600,000 * 0.15) = $570,000

17 | C M A U S ( P a r t I ) Complied By: Prof. Ravi Gupta

• Standard full manufacturing costs plus markup.

a. Standard full manufacturing costs plus markup.

19 | C M A U S ( P a r t I ) Complied By: Prof. Ravi Gupta

b. Market selling price of the product being transferred

Last Year’s Operating Results

A breakout of operating data by division is shown below.

APPAREL SHOES SPORTS

6. Discuss how contribution margin can be used as a performance evaluation tool.

2. The three retail divisions at blue mountain represent profit centers.

4. Contribution margin by division

Apparel Shoes Sports Equip. Total

21 | C M A U S ( P a r t I ) Complied By: Prof. Ravi Gupta

Apparel Shoes Sports Equip. Total

1. Explain how Maxwell could use management by exception.

2. Total direct labor rate variance $200F

3. Total direct labor efficiency variance $5000U

*SQ = 1500 * 1 hour

**SQ = 1500 * 3 hour

23 | C M A U S ( P a r t I ) Complied By: Prof. Ravi Gupta

1. Operating profit margin percentage = operating income /Net revenue

25 | C M A U S ( P a r t I ) Complied By: Prof. Ravi Gupta

1. Unit contribution = {$25,000,000 – [$16,500,000 + ($2,700,000]} ÷ 1,484,000

ROI = operating income ÷ average assets

Residual Income = operating income – mini required return on average assets

= $1,845,000 – ($15,375,000 * .11)

27 | C M A U S ( P a r t I ) Complied By: Prof. Ravi Gupta

• The level of sales to enter into the budget.

29 | C M A U S ( P a r t I ) Complied By: Prof. Ravi Gupta

1. Using absorption costing, calculate the following.

2. Using variable costing, calculate the following.

• Inman’s September manufacturing cost per unit

4. Identify and discuss one advantage of using each of the following:

b. September 30 inventory value:

2. $25500 hours 4units = $50,000 cost with no learning curve.

SQ = 1500 1 hour