FinMan Ch22 [Read-Only] · Performance Evaluation Using Variances from Cost Behavior and CostPerformance Evaluation Using Volume Profit Analysis Standard Costs - - Variances from

Performance Evaluation Using Variances from Cost Behavior and Cost Volume Profit AnalysisPerformance Evaluation Using Standard CostsCost Behavior and Cost-Volume-Profit AnalysisPerformance Evaluation Using Variances from Standard Costs

Chapter 22Chapter 22

Prepared by: C. Douglas Cloud Professor Emeritus of AccountingProfessor Emeritus of AccountingPepperdine University

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Learning ObjectivesLearning Objectives1. Describe the types of standards and how

they are established.2. Describe and illustrate how standards are

used in budgeting.3. Compute and interpret direct materials and

di t l b idirect labor variances.4. Compute and interpret factory overhead

controllable and ol me ariancescontrollable and volume variances.


Learning ObjectivesLearning Objectives5. Journalize the entries for recording

standards in the accounts and prepare an income statement that includes variances from standardfrom standard.

6. Describe and provide examples of nonfinancial performance measuresnonfinancial performance measures.


Learning Objective 1Learning Objective 1

Describe the types of standards and howstandards and how

they are established.


StandardsLO 1LO 1

Standards

Standards are performance goals. Standards are performance goals. Manufacturing companies normally use standard cost for each of these three product costs:1. Direct materials2. Direct labor3. Factory overhead


StandardsLO 1LO 1

Standards

Accounting systems that use standards for Accounting systems that use standards for product costs are called standard costsystems.

Standard cost systems enable management to determine: How much a product should cost (standard

cost)i ( ) How much it does cost (actual cost)


StandardsLO 1LO 1

Standards

When actual costs are compared with When actual costs are compared with standard costs, only the exceptions or variances are reported for cost control. This reporting by the principle of exceptionsallows management to focus on correcting th t ithe cost variances.


Setting StandardsLO 1LO 1

Setting Standards

The standard-setting process normally The standard setting process normally requires the joint efforts of accountants, engineers, and other management personnel.


Types of StandardsLO 1LO 1

Types of Standards

Unrealistic standards that can be achieved Unrealistic standards that can be achieved only under perfect operating conditions (such as no idle time, no machine breakdowns, and no materials spoilage) are called ideal standards or theoretical t d dstandards.


Types of StandardsLO 1LO 1

Types of Standards

Currently attainable standards, sometimes Currently attainable standards, sometimes called normal standards, can be attained with reasonable effort. Such standards, which are used by most companies, allow for normal production difficulties and

i t kmistakes.


Reviewing and Revising StandardsLO 1LO 1

Standard costs should be periodically

Reviewing and Revising Standards

Standard costs should be periodically reviewed to ensure that they reflect current operating conditions. Standards should not be revised, however, just because they differ from actual costs.


Criticisms of Standard CostsLO 1LO 1

Criticisms of Standard Costs

Standards limit operating improvements by Standards limit operating improvements by discouraging improvement beyond the standard.

Standards are too difficult to maintain in a dynamic manufacturing environment,

lti i “ t l t d d ”resulting in “stale standards.” Standards can cause workers to lose sight

of the larger objectives of the organization of the larger objectives of the organization by focusing only on efficiency improvements.


improvements.

Criticisms of Standard CostsLO 1LO 1

Criticisms of Standard Costs

Standards can cause workers to unduly Standards can cause workers to unduly focus on their own operations to the possible harm of other operations that rely on them.



Describe and illustrate how standards are used in budgeting.


Budgetary Performance EvaluationLO 2LO 2

Budgetary Performance Evaluation

The standard cost per unit for direct The standard cost per unit for direct materials, direct labor, and factory overhead is computed as follows:

Standard Cost Per Unit

Standard Price

Standard Quantity= x


Budgetary Performance EvaluationLO 2LO 2

Budgetary Performance Evaluation

Western Rider’s standard costs per unit for XLWestern Rider s standard costs per unit for XL jeans are shown in Exhibit 1.


Budget Performance ReportLO 2LO 2

Budget Performance Report

The report that summarizes actual costs, The report that summarizes actual costs, standard costs, and the differences for the units produced is called a budget performance report.




The differences between actual and The differences between actual and standard costs are called costs variances.

A favorable cost variance occurs when the A favorable cost variance occurs when the actual cost is less than the standard cost (at actual volumes).ac ua o u es).

An unfavorable cost variance occurs when the actual cost exceeds the standard costthe actual cost exceeds the standard cost.





Manufacturing Cost VariancesLO 2LO 2

Manufacturing Cost Variances

The total manufacturing cost variance is the The total manufacturing cost variance is the difference between total standard costs and total actual costs for the units produced.

For control purposes, each product cost variance is separated into two additional variances as shown in Exhibit 3 (next slide).






The total direct materials variance is


The total direct materials variance is separated into a price and quantityvariance.


Price Difference + Quantity Difference


The total direct labor variance is separated


The total direct labor variance is separated into a rate and a time variance.


Rate Difference + Time Difference


CCompute and interpret direct

i l d dimaterials and direct labor variances.


Direct Materials VariancesLO 3LO 3

Direct Materials VariancesDuring June, Western Rider reported an unfavorable total direct materials cost variance of $2,650 for the production of 5,000 XL style jeans as shown in Exhibit 2 and reproducedjeans, as shown in Exhibit 2 and reproduced below.

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. (continued)

LO 3LO 3

Direct Materials VariancesActual Direct Materials Cost = Actual Price x Actual QuantityA t l Di t M t i l C t ($5 50 d) (7 300

Direct Materials Variances

Actual Direct Materials Cost = ($5.50 per sq. yard) x (7,300 sq. yards.)Actual Direct Materials Cost = $40,150Standard Direct Materials Cost = Standard Price x Standard QuantityStandard Direct Materials Cost Standard Price x Standard QuantityStandard Direct Materials Cost = ($5.00 per sq. yard) x (7,500 sq.

yards.)Standard Direct Materials Cost = $37 500Standard Direct Materials Cost = $37,500Actual costs ($40,150) – Standard costs ($37,500) = $2,650

Total Unfavorable Materials Variance


LO 3LO 3

Direct Materials Price VarianceDirect Materials Price Variance

Di t M t i l P i V i (A t l P i St d d Direct Materials Price Variance = (Actual Price – Standard Price) x Actual Quantity

Direct Materials Price Variance = ($5 50 $5 00) x 7 300 Direct Materials Price Variance = ($5.50 – $5.00) x 7,300 sq. yds.

Direct Materials Price Variance = $3 650Direct Materials Price Variance = $3,650Unfavorable direct materials price variance

Western Rider paid $0.50 more per square yard of material than the standard

variance


square yard of material than the standard.

LO 3LO 3

Direct Materials Quantity VarianceDirect Materials Quantity Variance

Direct Materials Quantity Variance = (Actual Quantity –Standard Quantity) x Standard PriceStandard Price

Direct Materials Quantity Variance = (7,300 sq. yds. –7,500 sq. yds.) x $5.00 q y )

Direct Materials Quantity Variance = – $1,000Favorable direct materials quantityWestern Rider used 200

square yards less than the t d d

materials quantity variance


standard.

Direct Materials Variance RelationshipsLO 3LO 3

Direct Materials Variance Relationships

The relationship among the total direct The relationship among the total direct materials cost variance, the direct materials price variance, and the direct materials quantity variance is shown in an animated reproduction of Exhibit 4 in the

t lidnext slide.


Direct Materials Variance RelationshipsLO 3LO 3

Direct Materials Variance Relationships

Actual cost: Standard cost:Actual quantity x Standard price 7,300 x $5.00 =

Actual quantity x Actual price 7,300 x $5.50 =

Standard quantity x Standard price 7,500 x $5.00 =, $

$36,500, $

$40,150 $37,500

$3,650 U

Direct materials price variance

– $1,000 F

Direct materials quantity variance

$40,150 – $37,500 = $2,650 U

Total direct materials cost variance


EE 22-1


Direct Labor VariancesLO 3LO 3

Direct Labor Variances

During June, Western Rider reported an unfavorableDuring June, Western Rider reported an unfavorable total direct labor cost variance of $2,500 for the production of 5,000 XL style jeans, as shown in E hibit 2 d d d b lExhibit 2 and reproduced below.


Direct Labor VariancesLO 3LO 3

Direct Labor VariancesActual Direct Labor Cost = Actual Rate per Hour x Actual TimeActual Direct Labor Cost = $10.00 per hr. x 3,850 hrs.Actual Direct Labor Cost = $38,500

Standard Direct Labor Cost = Standard Rate per Hour x Standard Direct Labor Cost = Standard Rate per Hour x Standard Time

Standard Direct Labor Cost = $9.00 per hr. x 4,000 hrs.St d d Di t L b C t $36 000Standard Direct Labor Cost = $36,000Actual costs ($38,500) – Standard costs ($36,000) = $2,500

T t l f bl di tTotal unfavorable direct labor cost variance


Direct Labor Rate VarianceLO 3LO 3

Direct Labor Rate VarianceDirect Labor Rate Variance = (Actual Rate per Hour – Standard Rate per Hour) x Actual Hours

Direct Labor Rate Variance = ($10.00 – $9.00) x 3,850 hours

Di t L b R t V i $3 850Direct Labor Rate Variance = $3,850

Unfavorable direct labor rate variance

The unfavorable variance could have been caused by improper schedulingbeen caused by improper scheduling and use of employees.


Direct Labor Time VarianceLO 3LO 3

Direct Labor Time Variance

Direct Labor Time Variance = (Actual Direct Labor (Hours - Standard Direct Labor Hours) x Standard Rate per Hour

Direct Labor Time Variance = (3,850 hours – 4,000 direct labor hours) x $9.00

$Direct Labor Time Variance = – $1,350

If there had been an unfavorable timeFavorable direct laborIf there had been an unfavorable time

variance, it might have been caused by a shortage of skilled workers.

direct labor time variance


Direct Labor Variance RelationshipsLO 3LO 3

Direct Labor Variance Relationships

Actual cost: Standard cost:Actual hours x Standard rate 3,850 x $9 =

Actual hours x Actual rate 3,850 x $10 =

Standard hours x Standard rate 4 000 x $9 =

Actual cost: Standard cost:

3,850 $9$34,650

3,850 $ 0$38,500

4,000 x $9 $36,000

$3,850 U

Direct labor rate variance

–$1,350 F

Direct labor time variance

$3,850 U $1,350 F

$38,500 – $36,000 = $2,500 UTotal direct labor cost variance


EE 22-2



CCompute and interpret factory

h d ll bloverhead controllable volume variances.


Factory Overhead VariancesLO 4LO 4

Factory Overhead Variances

Factory overhead costs are more difficult to Factory overhead costs are more difficult to analyze than direct labor and materials costs. This is because factory overhead costs have fixed and variable cost elements.


Factory Overhead Flexible BudgetLO 4LO 4

Factory Overhead Flexible Budget




Factory Overhead Rate

Budgeted Factory Overhead at Normal Capacity

Normal Productive Capacity=

Normal Productive Capacity

$30,0005,000 direct labor hoursFactory Overhead Rate =5,000 direct labor hours

Factory Overhead Rate = $6.00 per direct labor hour




Variable Factory Overhead Rate =

Budgeted Variable Overhead at Normal Capacity

Normal Productive Capacityo a oduc e Capac y

$18,0005,000 direct labor hoursVariable Factory Overhead Rate =

Variable Factory Overhead Rate = $3.60 per direct labor hour

5,000 direct labor hours




Fixed Factory Overhead Rate =

Budgeted Fixed Overhead at Normal Capacity

Normal Productive CapacityNormal Productive Capacity

$12,000Fixed Factory Overhead Rate =5,000 direct labor hours

Fixed Factory Overhead Rate =

Fixed Factory Overhead Rate = $2.40 per direct labor hour


Variable Factory Overhead Controllable VarianceLO 4LO 4

Variable Factory Overhead Controllable Variance

Variable FactoryActual Variable

Factory Overhead=Budgeted Variable Factory Overhead

–Variable Factory

Overhead Controllable

VarianceVariance

Standard Hours for Actual Units Produced

Variable Factory

Overhead x

Rate




The budgeted variable factory overhead is The budgeted variable factory overhead is the standard variable overhead for the actual units produced.




Variable FactoryBudgeted Variable Factory Overhead$14,400Actual Variable

Factory Overhead= –

Variable Factory Overhead Controllable

Variance

=


Variance $10,400 – $14,4004,000 direct labor hours x $3.60

=


Variance – $4,000 Favorable VarianceVariance $4,000 Favorable Variance


EE 22-3


Fixed Factory Overhead Volume VarianceLO 4LO 4

Fixed Factory Overhead Volume Variance

Standard StandardFixed Factory FixedStandard Hours for 100%

of Normal Capacity

=

Standard Hours for

Actual Units Produced

yOverhead Volume Variance

–

Fixed Factory

Overhead Rate

x

Capacity ProducedVariance Rate

=

Fixed Factory Overhead 5,000 direct 4,000 direct x $2 40=Volume Variance

,labor hours

,labor hours x $2.40–

=Fixed Factory

Overhead Volume

$2,400 Unfavorable Variance


Variance

LO 4LO 4

Fixed Factory Overhead Volume VarianceFixed Factory Overhead Volume Variance


LO 4LO 4


An unfavorable volume variance may be


An unfavorable volume variance may be due to factors such as: Failure to maintain an even flow of work Machine breakdowns Work stoppages caused by lack of materials pp g y

or skilled labor Lack of enough sales orders to keep the

f t ti t l itfactory operating at normal capacity


EE 22-4


Reporting Factory Overhead VariancesLO 4LO 4

Reporting Factory Overhead Variances

A factory overhead cost variance report is A factory overhead cost variance report is useful to management in controlling factory overhead costs.

Exhibit 8 (next slide) illustrates this report for Western Rider Inc. for June.


Reporting Factory Overhead VariancesLO 4LO 4

Reporting Factory Overhead Variances


Factory Overhead AccountLO 4LO 4

Factory Overhead Account

AppliedApplied Factory

OverheadStandard Hours for

Actual Units Produced= Total Factory Overhead Ratex

Applied Factory

Overhead=

5,000 jeans x 0.80 direct labor hr. per pair

of jeansx $6.00

Applied F t

Overhead of jeans

Factory Overhead

= 4,000 direct labor hrs. x $6.00 = $24,000


LO 4LO 4

Factory Overhead AccountFactory Overhead Account

Actual Factory Overhead= Applied Factory

Overhead–Total Factory Overhead Cost Variance

Standard Hours for Actual Units Produced

Total Factory Overhead Rate

xActual Units Produced Overhead Rate

(continued)


( )

LO 4LO 4


Actual Factory Overhead= Applied Factory

Overhead–Total Factory Overhead Cost Variance

5,000 jeans x 0.80 direct labor hr. per

pair of jeans

$6.00x

pair of jeans

(continued)


( )

LO 4LO 4


Actual Factory Overhead= –Total Factory Overhead

Cost Variance $24,000

5,000 jeans x 0.80 direct labor hr. per

pair of jeans

$6.00x

pair of jeans

(continued)


( )

LO 4LO 4


Actual Factory Overhead= –Total Factory Overhead

Cost Variance $24,000

$22,400 – $24,000=Total Factory Overhead Cost Variance

– $1,600 Favorable Variance =Total Factory Overhead Cost Variance




Underapplied and overapplied factory Underapplied and overapplied factory overhead account balances represent the following total factory overhead cost variances: Underapplied Factory Overhead =

U f bl T t l F t O h d C t Unfavorable Total Factory Overhead Cost Variance Overapplied Factory Overhead = Favorable Overapplied Factory Overhead = Favorable

Total Factory Overhead Cost Variance


LO 4LO 4


Factory Overhead

Applied factoryActual factory Applied factory overhead 24,000

Actual factory overhead 22,400

$10 400 + $12 000 4 000 hours x $6 00 per hour$10,400 + $12,000 4,000 hours x $6.00 per hour




Factory Overhead

Applied factoryActual factory Applied factory overhead 24,000

Actual factory overhead 22,400

Balance June 30 1 600Balance, June 30 1,600

Overapplied factory

h d© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

overhead


Factory Overhead AccountActual factory overhead $22,400 Applied factory overhead $24,000

A li d F

Budgeted Factory Overhead for Amount

ProducedA t l F t Applied Factory Overhead

$24,000Variable factory OH $14,400Fixed factory OH 12,000T t l $26 400

Actual Factory Overhead

$22,400Total $26,400

$ $2 400 UControllable

VarianceVolume

Variance

– $4,000 F $2,400 U

– $1,600 F


Total Factory Overhead Cost Variance$1,600 F


Journalize the entries for recording standards in the accounts and prepare an

income statement that includes variances from

standard.


Recording and Reporting VariancesLO 5LO 5

Recording and Reporting Variances

Standard costs may be used as a Standard costs may be used as a management tool to control costs separately from the accounts in the general ledger.

However, many companies include both standard costs and variances, in addition to actual costs, in their accounts.


LO 5LO 5

Recording and Reporting VariancesRecording and Reporting Variances

Western Rider Inc. purchased, on account, theWestern Rider Inc. purchased, on account, the 7,300 square yards of blue denim at $5.50 per square yard. The standard price is $5.00 per square yard. The entry to record the purchase and the unfavorable direct materials price variance is as f llfollows:


LO 5LO 5


$5.50 x 7,300 = $40,150

$5 00 x 7 300 = $36 500$3,650 unfavorable direct

$5.00 x 7,300 = $36,500 materials price variance


LO 5LO 5


Western Rider Inc. used 7,300 square yards of blueWestern Rider Inc. used 7,300 square yards of blue denim to produce 5,000 pairs of XL jeans. The standard quantity of denim for the 5,000 jeans produced is 7,500 square yards. The entry to record the materials used is as follows:


LO 5LO 5


$5.00 x 7,500 = $37,500

$5 00 x 7 300 = $36 500– $1,000 favorable direct

$5.00 x 7,300 = $36,500 materials quantity variance


EE 22-5


LO 5LO 5


Two journal entries are usually required for Two journal entries are usually required for the purchase and use of direct materials because they are rarely the same amount.

Direct labor can be recorded in a single entry because “what you buy is what you use.”

The diagram in the next illustration was t k f hibit h di t l b taken from Exhibit 5 where direct labor variances were illustrated.


LO 5LO 5


Work in Progress 36,000Direct Labor Rate Variance 3,850

Direct Labor Time Variance 1,350


Wages Payable 38,500

LO 5LO 5


Work in Progress 36,000Direct Labor Rate Variance 3,850

Direct Labor Time Variance 1,350


Wages Payable 38,500

Recording and Reporting VariancesLO 5LO 5

Recording and Reporting Variances


EE 22EE 22--66


EE 22-6



Describe and provide examples

of nonfinancial performance measures.


Nonfinancial Performance MeasuresLO 6LO 6

Nonfinancial Performance Measures

A nonfinancial performance measureA nonfinancial performance measureexpresses performance in a measure other than dollars.



Nonfinancial Performance Measures Inventory turnover Percent on-time delivery Elapsed time between a customer order and

d t d liproduct delivery Customer preference rankings compared to

competitorscompetitors Response time to a service call Time to develop new products Time to develop new products Employee satisfaction Number of customer complaints


Number of customer complaints



Nonfinancial measures can be linked to Nonfinancial measures can be linked to either the inputs or outputs of an activity or process.

A process is a sequence of activities linked together for performing a particular task.



Counter Service Activity of a


Counter Service Activity of a Fast-Food Restaurant

OutputsLine wait

InputsNumber of employeesEmployee experience Line wait

Percent order accuracy

Friendly service

ActivityCounter service

Employee trainingFryer reliabilityNumber of new menu Friendly service

scoreitemsFountain drinks available


EE 22-7


Performance Evaluation Using Variances from Performance Evaluation Using Variances from Cost Behavior and Cost Volume Profit AnalysisPerformance Evaluation Using Standard CostsStandard CostsCost Behavior and Cost-Volume-Profit AnalysisPerformance Evaluation Using Variances from Standard Costs

The EndThe End

Prepared by: C. Douglas Cloud Professor Emeritus of AccountingProfessor Emeritus of AccountingPepperdine University


Documents

FinMan Ch22 [Read-Only] · Performance Evaluation Using Variances from Cost Behavior and CostPerformance Evaluation Using Volume Profit Analysis Standard Costs - - Variances from