AC239AC239Managerial AccountingManagerial Accounting

Seminar 7Seminar 7Jim Eads, CPA, MST, MSFJim Eads, CPA, MST, MSF

Performance Evaluation Using Performance Evaluation Using Variances from Standard CostsVariances from Standard Costs

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StandardsStandards

StandardsStandards are performance goals. are performance goals. Manufacturers normally use standard costs Manufacturers normally use standard costs for each of the three manufacturing costs:for each of the three manufacturing costs: Direct materialsDirect materials Direct laborDirect labor Factory overheadFactory overhead

A A standard cost system standard cost system uses uses standards for direct materials, direct standards for direct materials, direct labor, and factory overhead.labor, and factory overhead.

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StandardsStandards

Ideal standardsIdeal standards or or theoretical theoretical standards standards can be achieved only can be achieved only under perfect operating under perfect operating conditions (such as no idle time, conditions (such as no idle time, no machine breakdowns, no no machine breakdowns, no materials spoilage). materials spoilage).

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StandardsStandards

Currently attainable standardsCurrently attainable standards or or normal standards normal standards can becan be attained with reasonable effort. attained with reasonable effort. Standards set at this level allow Standards set at this level allow for disruptions, such as material for disruptions, such as material spoilage and machine spoilage and machine breakdownsbreakdowns

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Criticisms of StandardsCriticisms of Standards Standards limit operating Standards limit operating

improvements by discouraging improvements by discouraging improvements beyond the standard.improvements beyond the standard.

Standards are too difficult to Standards are too difficult to maintain in a dynamic maintain in a dynamic manufacturing environment, manufacturing environment, resulting in “stale standardsresulting in “stale standards

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Criticisms of StandardsCriticisms of Standards Standards can cause workers to lose Standards can cause workers to lose

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

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

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StandardsStandards

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BudgetBudgetPerformance ReportPerformance Report

The The budget performance reportbudget performance report summarizes the actual costs, the standard summarizes the actual costs, the standard costs for the actual level of production costs for the actual level of production achieved, and the differences between achieved, and the differences between the two amounts (called the two amounts (called cost variancescost variances).).A A favorablefavorable cost variance occurs when the cost variance occurs when the

actual cost is less than the standard.actual cost is less than the standard.An An unfavorableunfavorable cost variance occurs when the cost variance occurs when the

actual cost exceeds the standard.actual cost exceeds the standard.

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BudgetBudgetPerformance ReportPerformance Report

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VariancesVariances Direct materials cost varianceDirect materials cost variance

– Quantity varianceQuantity variance– Price VariancePrice Variance

Direct labor cost varianceDirect labor cost variance– Labor time varianceLabor time variance– Labor rate varianceLabor rate variance

Factory Overhead cost varianceFactory Overhead cost variance– Variable controllable varianceVariable controllable variance– Fixed volume variance Fixed volume variance

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Quantity VarianceQuantity Variance

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Standard square yards per unit 1.50Actual units produced X 5,000Standard square yards for units produced 7,500Standard price per square yard X $5.00Standard direct materials cost for units produced $37,500

Actual square yards used 7,300Standard square yards for units produced 7,500Quantity variance (favorable) 200Standard price per square yard X $5.00Quantity cost variance (favorable) $1,000

Materials VarianceMaterials Variance

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Standard square yards per unit 1.50Actual units produced X 5,000Standard square yards for units produced 7,500Standard price per square yard X $5.00Standard direct materials cost for units produced

$37,500

Actual square yards used 7,300Actual price per square yard $5.50

Price/Quantity Price/Quantity VarianceVariance

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Actual price per square yard $5.50Standard price per square yard - 5.00Price variance (unfavorable per square yard) $0.50Actual square yards used x 7,300Unfavorable price variance $3,650

Actual square yards used 7,300Standard square yards for units produces - 7,500Quantity variance (favorable square yards) (200)Standard price per square yard $5.00Favorable quantity variance $1,000

Price/Quantity Price/Quantity VarianceVariance

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Standard direct materials cost: 7,500 x $5.00 $37,500

Variances: Quantity variance (favorable) 200 x $5.00 ($1,000) Price variance (unfavorable) 7,300 x $0.50 $3,650 Total direct materials cost variance (unfavorable)

$2,650

Labor VarianceLabor Variance

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Standard labor hours per unit 0.80Actual units produced X 5,000Standard labor hours for units produced 4,000Standard labor rate X $9.00Standard direct labor cost for units produced $36,000

Actual labor hours used 3,850Actual labor rate per hour $10.00

Rate/Time VarianceRate/Time Variance

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Actual rate per labor hour $10.00Standard rate per labor hour - 9.00Price variance (unfavorable per labor hour) $1.00Actual labor hours used x 3,850Unfavorable direct labor rate variance $3,850

Actual labor hours used 3,850Standard labor hours units produces - 4,000Time variance (favorable labor hours) (150)Standard price per labor hour $9.00Favorable time variance $1,350

Rate/Time VarianceRate/Time Variance

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Standard direct labor cost: 4,000 x $9.00 $36,000

Variances: Time variance (favorable) 150 x $9.00 ($1,350) Rate variance (unfavorable) 3,850 x $1.00 $3,850 Total direct labor cost variance (unfavorable) $2,500

Overhead VarianceOverhead Variance

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Overhead VarianceOverhead Variance

Variances from standard for factory Variances from standard for factory overhead cost result from:overhead cost result from:

Actual variable factory overhead cost Actual variable factory overhead cost greater or less than budgeted variable greater or less than budgeted variable factory overhead for actual production.factory overhead for actual production.Actual production at a level above or Actual production at a level above or below 100% of normal capacity.below 100% of normal capacity.

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Overhead VarianceOverhead Variance

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Actual variable factory overhead $10,400

Budgeting variable factory overhead for hours used (4,000 hours x $3.60) 14,400

Controllable factory overhead variance (favorable)

$4,000

Example Exercise 23-3Example Exercise 23-3(page 1056)(page 1056)

Tip Top Corp. produced 3,000 units of Tip Top Corp. produced 3,000 units of product that required 2.5 standard product that required 2.5 standard hours per unit. The standard hours per unit. The standard variable overhead cost per unit is variable overhead cost per unit is $2.20 per hour. The actual variable $2.20 per hour. The actual variable factory overhead was $16,850. factory overhead was $16,850. Determine the variable factory Determine the variable factory overhead controllable variance.overhead controllable variance.

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Example Exercise 23-3Example Exercise 23-3(page 1056)(page 1056)

$350 unfavorable$350 unfavorable

Budgeted variable overhead cost = Budgeted variable overhead cost = $2.20 x 3,000 units x 2.5 hours $2.20 x 3,000 units x 2.5 hours per unit = $16,500per unit = $16,500

$16,850 actual variable overhead $16,850 actual variable overhead cost - $16,500 budgeted variable cost - $16,500 budgeted variable overhead cost = $350 overhead cost = $350 unfavorableunfavorable

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OverheadOverheadVariance ReportVariance Report

Total actual factory overheadTotal actual factory overhead– $22,400$22,400

Factory overhead appliedFactory overhead applied– 4,000 hours x $6.00 per hour = 4,000 hours x $6.00 per hour =

$24,000$24,000 Total factory overhead cost Total factory overhead cost variancevariance

– $1,600 favorable$1,600 favorable

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OverheadOverheadVariance ReportVariance Report

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Example Exercise 23-4Example Exercise 23-4(page 1058)(page 1058)

Tip Top Corp. produced 3,000 units Tip Top Corp. produced 3,000 units of product that required 2.5 of product that required 2.5 standard hours per unit. The standard hours per unit. The standard fixed overhead cost per standard fixed overhead cost per unit is $0.90 per hour at 8,000 unit is $0.90 per hour at 8,000 hours, which is 100% of normal hours, which is 100% of normal capacity. Determine the fixed capacity. Determine the fixed factory overhead volume variance.factory overhead volume variance.

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Example Exercise 23-4Example Exercise 23-4(page 1058)(page 1058)

$450 unfavorable$450 unfavorableBudgeted fixed overhead hours = Budgeted fixed overhead hours =

8,000 hours8,000 hoursActual fixed overhead hours = Actual fixed overhead hours =

3,000 x 2.5 = 7,5003,000 x 2.5 = 7,500Fixed factory overhead volume Fixed factory overhead volume

variance = (8,000 – 7,500) x variance = (8,000 – 7,500) x $0.90 = $450$0.90 = $450

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Recording VariancesRecording Variances

Standard costs can be used solely Standard costs can be used solely as a management tool separate as a management tool separate from the accounts in the general from the accounts in the general ledger. However, many ledger. However, many companies include both standard companies include both standard costs and variances, in addition to costs and variances, in addition to actual costs, in their accounts.actual costs, in their accounts.

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Recording VariancesRecording Variances

Western Rider Inc. purchased, on Western Rider Inc. purchased, on account, the 7,300 square yards of account, the 7,300 square yards of blue denim at $5.50 per square yard. blue denim at $5.50 per square yard. The standard price was $5.00 per The standard price was $5.00 per square yard.square yard.

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Materials (7,300 sq. yds. X $5.00) 36,500Direct Materials Price Variance 3,650 Accounts Payable (7,300 sq yds. X $5.50)

40,150

Recording VarianceRecording Variance

Western Rider Inc. used 7,300 square Western Rider Inc. used 7,300 square yards of blue denim to produce 5,000 yards of blue denim to produce 5,000 pairs of XL jeans, compared to the pairs of XL jeans, compared to the standard of 7,500 square yards. standard of 7,500 square yards.

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Work in Process (7,500 sq. yds. X $5.00) 37,500Direct Materials Quantity Variance 1,000 Materials (7,300 sq yds. X $5.00) 36,500

Questions?Questions?

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One last thought….One last thought….

Make sure you read through Make sure you read through Chapter 24 Chapter 24 beforebefore next week’s next week’s seminar.seminar.

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