AC239 Unit 7 Chapter 23 Performance Evaluation Using Variances from Standard Costs

Standards Standards are performance goals. Manufacturers normally use standard costs for each of the three product costs: Direct materials Direct labor Factory overhead 1 2

Accounting systems that use standards for direct materials, direct labor, and factory overhead are called standard cost systems. 1 3

When actual costs are compared with standard costs, only the exceptions or variances are reported for cost control (called reporting by the principle of exceptions). Such reports allow management to focus on correcting the cost variances. 1 4

The standard-setting process normally requires the joint efforts of accountants, engineers, and other management personnel. Setting Standards 1 5

Unrealistic standards that can be achieved only under perfect operating conditions (such as no idle time, no machine breakdowns, no materials spoilage) are called ideal standards or theoretical standards. Types of Standards 1 6

Currently attainable standards, sometimes called normal standards, can be attained with reasonable effort. Standards set at this level allow for disruptions, such as material spoilage and machine breakdowns. 1 7

Standard costs should be periodically reviewed to ensure that they reflect current operating conditions. Standards should be revised when they no longer reflect operating conditions. Reviewing and Revising Standards 1 8

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 2 9

Standard Cost for XL Jeans 2 Exhibit 1 10

Budget Performance Report The report that summarizes actual costs, standard cost, and the differences for the units produced is called a budget performance report. 2 11

A favorable cost variance occurs when the actual cost is less than the standard cost (at actual volumes). An unfavorable cost variance occurs when the actual cost exceeds the standard cost (at actual volumes). 2 12

Budget Performance Report 2 Exhibit 2 13

Manufacturing Cost Variance The total manufacturing cost variance is the difference between total standard costs and total actual cost for the units produced. 2 14

Manufacturing Cost Variances 2 Exhibit 3 15

The total direct materials variance is separated into price and quantity variances. Direct Materials Variance 2 16

The total direct labor variance is separated into rate and time variances. Direct Labor Variance 2 17

Direct Materials Variances Actual Direct Materials Cost = Actual Price × Actual Quantity Actual Direct Materials Cost = $5.50 × (7,300 sq. yards.) Actual Direct Materials Cost = $40,150 Standard Direct Materials Cost = Standard × Standard Quantity Standard Direct Materials Cost = $5.00 × (7,300 sq. yards.) Standard Direct Materials Cost = $37,150 Actual costs ($40,150) – Standard costs ($37,500) = $2,650 Total Unfavorable Materials Variance 3 18

Direct Materials Price Variance Direct Materials Price Variance = (Actual Price – Standard Price) × Actual Quantity Direct Materials Price Variance = ($5.50 – $5.00) × 7,300 sq. yds. Direct Materials Price Variance = $3,650 Unfavorable Variance Western Rider paid $0.50 more per square yard of material than the standard. 3 19

Direct Materials Quantity Variance Direct Materials Quantity Variance = (Actual Quantity – Standard Quantity) × Standard Price Direct Materials Quantity Variance =(7,300 sq. yds. – 7,500 sq. yds. × $5.00 Direct Materials Price Variance = ($1,000) Favorable Variance Western Rider used 200 less square yards of material than the standard. 3 20

Direct Materials Variance Relationships $3,650 U Materials price variance Actual quantity × Standard price 7,300 × $5.00 = $36,500 Actual quantity × Actual price 7,300 × $5.50 = $40,150 Standard quantity × Standard price 7,500 × $5.00 = $37,500 ($1,000) F Material quantity variance Actual cost: Standard cost: $40,150 – $37,500 = $2,650 U Total direct materials cost variance 3 Exhibit 4 21

Direct Labor Variances Actual Direct Labor Cost = Actual Rate per Hour × Actual Time Actual Direct Labor Cost = $10.00 per hr. × 3,850 hrs. Actual Direct Labor Cost = $38,500 Standard Direct Labor Cost = Standard Rate per Hour × Standard Time Standard Direct Labor Cost = $9.00 per hr. × 4,000 hrs. Standard Direct Labor Cost = $36,000 Actual costs ($38,500) – Standard costs ($36,000) = $2,500 Total Unfavorable Labor Variance 3 22

Direct Labor Rate Variance Direct Labor Rate Variance = (Actual Rate per Hour – Standard Rate per Hour) × Actual Hours Direct Labor Rate Variance = ($10.00 – $9.00) × 3,850 hours Direct Labor Rate Variance = $3,850 Unfavorable Variance If the actual direct labor rate for the units produced is less than the standard direct labor rate, the variance is favorable. 3 23

Direct Labor Time Variance Direct Labor Time Variance = (Actual Direct Labor Hours – Standard Direct Labor Hours) × Standard Rate per Hour Direct Labor Time Variance =(3,850 hours – 4,000 direct labor hours) × $9.00 Direct Labor Time Variance = ($1,350) Favorable Variance If the actual direct hours for the units produced exceeds the standard direct labor hours, the variance is unfavorable. 3 24

Direct Labor Variance Relationships Actual hours × Standard rate 3,850 × $9 = $34,650 Actual hours × Actual rate 3,850 × $10 = $38,500 $3,850 U Direct labor rate variance Standard hours × Standard rate 4,000 × $9 = $36,000 ($1,350) F Direct labor time variance Actual cost: Standard cost: $38,500 – $36,000 = $2,500 U Total direct labor cost variance 3 Exhibit 5 25

Factory overhead costs are more difficult to analyze than are direct labor and materials costs. This is because factory overhead costs have fixed and variable cost elements. 4 26

Factory Overhead Cost Budget Indicating Standard Factory Overhead Rate 4 Exhibit 6 27

Factory Overhead Rate = The Factory Overhead Flexible Budget Budgeted Factory Overhead at Normal Capacity Normal Productive Capacity Factory Overhead Rate = $30,000 5,000 direct labor hours Factory Overhead Rate = $6.00 per direct labor hour 4 28

Fixed Factory Overhead Rate = Fixed Factory Overhead Rate Budgeted Fixed Overhead at Normal Capacity Normal Productive Capacity Fixed Factory Overhead Rate = $2.40 per direct labor hour $12,000 5,000 direct labor hours Fixed Factory Overhead Rate = 4 29

Variable Factory Overhead Rate = Variable Factory Overhead Rate Budgeted Fixed Overhead at Normal Capacity Normal Productive Capacity Variable Factory Overhead Rate = $3.60 per direct labor hour $18,000 5,000 direct labor hours Variable Factory Overhead Rate = 4 30

Variable Factory Overhead Variances Actual Variable Factory Overhead = Budgeted Variable Factory Overhead – Variable Factory Overhead Controllable Variance Standard Hours for Actual Units Produced Variable Factory Overhead Rate × 4 31

Variable Factory Overhead Variances Actual Variable Factory Overhead = Budgeted Variable Factory Overhead – Variable Factory Overhead Controllable Variance 4,000 direct labor hours × $3.60 $14,

Variable Factory Overhead Controllable Variance = $10,400 – $14,400 Variable Factory Overhead Controllable Variance = $(4,000) Favorable Variance Actual Variable Factory Overhead = – Variable Factory Overhead Controllable Variance $14,

Fixed Factory Overhead Variances Standard Hours for 100% of Normal Capacity = Standard Hours for Actual Units Produced Fixed Factory Overhead Volume Variance – Fixed Factory Overhead Rate × = Fixed Factory Overhead Volume Variance 5,000 direct labor hours 4,000 direct labor hours $2.40 × – = Fixed Factory Overhead Volume Variance $2,400 Unfavorable Variance 4 34

Reasons for an Unfavorable Volume Variance 1.Failure to maintain an even flow of work 2.Machine breakdowns 3.Work stoppage caused by lack of materials or skilled labor 4.Lack of enough sales orders to keep the factory operating at normal capacity 4 35

Factory Overhead Cost Variance Report 4 Exhibit 8 36

Actual Factory Overhead = Applied Factory Overhead – Total Factory Overhead Cost Variance Standard Hours for Actual Units Produced Total Factory Overhead Rate × 4 37

Actual Factory Overhead = Applied Factory Overhead – Total Factory Overhead Cost Variance 5,000 jeans x 0.80 direct labor hr. per pair of jeans $6.00 × 4 38

5,000 jeans x 0.80 direct labor hr. per pair of jeans $6.00 × Actual Factory Overhead = – Total Factory Overhead Cost Variance Applied Factory Overhead $24,

$22,400 = – Total Factory Overhead Cost Variance $24,000 Total Factory Overhead Cost Variance = $(1,600) Favorable Variance Actual Factory Overhead = - Total Factory Overhead Cost Variance Applied Factory Overhead $24,

Factory Overhead Variances and the Factory Overhead Account Factory Overhead Actual factory overhead22,400 Applied factory overhead24,000 $10,400 + $12,000 4,000 hours × $6.00 per hour 4 41

Balance, June 301,600 Overapplied factory overhead Factory Overhead Actual factory overhead22,400 Applied factory overhead24,

Actual Factory Overhead $22,400 Controllable Variance Applied Factory Overhead $24,000 Volume Variance Budgeted Factory Overhead for Amount Produced Variable factory OH$14,400 Fixed factory OH 12,000 Total$26,400 Factory Overhead Actual factory overhead 22,400 Applied factory overhead 24,000 $(4,000) F$2,400 U Total Factory Overhead Cost Variance $(1,600) F 4 43

Standard costs may be used as a management tool 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. 5 44

Western Rider Inc. purchased, on account, the 7,300 square yards of blue denim at $5.50 per square yard. The standard price was $5.00 per square yard. Recording and Reporting Variances from Standards 5 45

Western Rider Inc.’s Purchase of Materials Entry $5.50 × 7,300 = $40,150 $5.00 × 7,300 = $36,500 $3,650 U Direct materials price variance 5 46

Western Rider Inc. used 7,300 square yards of blue denim to produce 5,000 pairs of XL jeans, compared to the standard of 7,500 square yards. 5 47

Western Rider Inc.’s Use of Materials Entry $5.00 × 7,500 = $37,500 $5.00 × 7,300 = $36,500 $(1,000) F Direct materials quantity variance 5 48

Variances from Standards in Income Statement 5 Exhibit 9 49

Internal Use Only The income statement shown in Exhibit 9 is for internal use by management. Variances are not reported to external users. 5 50

A nonfinancial performance measure is a performance measure expressed in units other than dollars. Nonfinancial Performance Measures 6 51

Inventory turnover Percent on-time delivery Elapsed time between a customer order and product delivery Customer preference rankings compared to competitors Response time to a service call Time to develop new products Employee satisfaction Number of customer complaints 6 Nonfinancial Performance Measures 52

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. 6 53

Outputs Line wait Percent order accuracy Friendly service score Activity Counter service Inputs Employee training Employee experience Number of new menu items Number of employees Fryer reliability Fountain drinks available Counter Service Activity of a Fast-Food Restaurant 6 54