The Problem: Use of Payoff Tables (Appendix); Spreadsheet Application Past exper

Question

The Problem: Use of Payoff Tables (Appendix); Spreadsheet Application Past experience indicates a 75% prob- ability that a reported overhead cost variance is not due to a specific cause (i.e., is attributable to random fluctuations). Past experience also shows that the average cost to investigate the underlying cause of a variance is $1,200 and that the cost to correct an out-of-control process is, on average, $3,800. If the underlying variance is systematic and management decides not to investigate the cause of the variance, the costs are thought to be significant: $28,000. Required: Set up an Excel spreadsheet to answer the following questions: 1. Given the preceding information, what is the expected value of investigating the reported variance? 2. Prepare a payoff table that summarizes the above information. (Hint: Your table should include cells for combinations of management actions (investigate vs. do not investigate) and states of nature (systematic cause vs. random event), plus cells to represent the expected cost of each management action. 3. Given the above information, what is the probability level, p, for nonrandom variance that makes man- agement indifferent between the two courses of action: investigate versus do not investigate? (Hint: You can use the formula in the text to calculate p. You could also use the Goal Seek function from the Tools menu in Excel to calculate this number.)" 4. writing a paper that evaluates variance analysis and its effectiveness as a tool for measuring performance. Discuss how analysis of variance can be useful for all types of organizations.

Explanation / Answer

Payoff table for variance Investigation ---

1. Expected value of the decision to investigate the variance.

E(Investigate) = [(I x (1-p)] + [(I + C) x p]

= [($1200 x (1-0.25)] + [($1200 + $3800) x 0.25]

= $2150

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