Based on Experience, You Observe the Following Probabilities Regarding the Underlying

question 132

Essay

Based on experience, you observe the following probabilities regarding the underlying cause of an observed cost or revenue variance: the probability, p, of a random variance equals 0.10, and the probability, 1 − p of a nonrandom variance equals 0.90. If management chooses to investigate, the total cost is $1,000 if it is concluded that the reported variance is a random fluctuation, while the total cost is $6,000 if it is concluded that the variance is the result of a nonrandom (i.e., a systematic) cause (i.e., the incremental cost to correct the variance is $5,000). On the other hand, if an observed variance is not investigated, management expects the following costs: if it is concluded that the variance is due to random causes, the cost would be $0; if it is concluded that the observed variance is due to a nonrandom (i.e., a systematic) cause, the cost would be $30,000.

Given this information, what is the expected cost (to the nearest whole dollar) of the decision to investigate the observed variance, E(investigate)?
A) $0.
B) $1,500.
C) $3,000.
D) $5,500.
E) $6,000.

• A) $0.
• B) $1,500.
• C) $3,000.
• D) $5,500.
• E) $6,000.

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Definitions:

Standard Costing

A costing method that assigns average costs to each production unit, based on estimated direct materials, labor, and overhead costs.

Variable Overhead

This consists of expenses that vary with production output, including costs not directly tied to manufacturing but essential for operation.

Labour Efficiency Variance

The difference between the actual labor hours used and the standard labor hours set for the production level achieved.

Incremental Cost Approach

A decision-making process focusing on the costs that change with the level of production or the introduction of a new process.