AC239 Managerial Accounting Seminar 7 Jim Eads, CPA, MST, MSF Performance Evaluation Using Variances from Standard Costs 1

Standards Standards are performance goals. Manufacturers normally use standard costs for each of the three manufacturing costs:  Direct materials  Direct labor  Factory overhead A standard cost system uses standards for direct materials, direct labor, and factory overhead. 2

Standards Ideal standards or theoretical standards can be achieved only under perfect operating conditions (such as no idle time, no machine breakdowns, no materials spoilage). 3

Standards Currently attainable standards or normal standards can be attained with reasonable effort. Standards set at this level allow for disruptions, such as material spoilage and machine breakdowns 4

Criticisms of Standards  Standards limit operating improvements by discouraging improvements beyond the standard.  Standards are too difficult to maintain in a dynamic manufacturing environment, resulting in “stale standards 5

Criticisms of Standards Standards can cause workers to lose sight of the larger objectives of the organization by focusing only on efficiency improvements. Standards can cause workers to lose sight of the larger objectives of the organization by focusing only on efficiency improvements. Standards can cause workers to unduly focus upon their own operations to the possible harm of other operations that rely on them. Standards can cause workers to unduly focus upon their own operations to the possible harm of other operations that rely on them. 6

Standards 7

Budget Performance Report The budget performance report summarizes the actual costs, the standard costs for the actual level of production achieved, and the differences between the two amounts (called cost variances). A favorable cost variance occurs when the actual cost is less than the standard. An unfavorable cost variance occurs when the actual cost exceeds the standard. 8

Budget Performance Report 9

Variances Direct materials cost variance Direct materials cost variance –Quantity variance –Price Variance Direct labor cost variance Direct labor cost variance –Labor time variance –Labor rate variance Factory Overhead cost variance Factory Overhead cost variance –Variable controllable variance –Fixed volume variance 10

Direct Materials Variance Actual units produced = 5,000 Actual units produced = 5,000 Standard quantity = 5,000 x 1.5 = 7,500 Standard quantity = 5,000 x 1.5 = 7,500 Actual quantity used = 7,300 Actual quantity used = 7,300 Standard cost per unit = $5.00 Standard cost per unit = $5.00 Actual cost per unit = $5.50 Actual cost per unit = $

Direct Materials Variance 12 Actual price per square yard$5.50 Standard price per square yard Price variance (unfavorable per square yard)$0.50 Actual square yards used x 7,300 Unfavorable price variance$3,650 Actual square yards used7,300 Standard square yards for units produces- 7,500 Quantity variance (favorable square yards)(200) Standard price per square yard$5.00 Favorable quantity variance$1,000

Direct Materials Variance 13 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

Direct Labor Variance Actual units produced = 5,000 Actual units produced = 5,000 Standard hours per unit = 0.8 Standard hours per unit = 0.8 Standard hours for units produced = 4,000 Standard hours for units produced = 4,000 Actual hours used = 3,850 Actual hours used = 3,850 Standard cost per hour = $9.00 Standard cost per hour = $9.00 Actual cost per unit = $10.00 Actual cost per unit = $

Rate/Time Variance 15 Actual rate per labor hour$10.00 Standard rate per labor hour Price variance (unfavorable per labor hour)$1.00 Actual labor hours used x 3,850 Unfavorable direct labor rate variance$3,850 Actual labor hours used3,850 Standard labor hours units produces- 4,000 Time variance (favorable labor hours)(150) Standard price per labor hour$9.00 Favorable time variance$1,350

Rate/Time Variance 16 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 Variance 17

Overhead Variance Variances from standard for factory overhead cost result from: Actual variable factory overhead cost greater or less than budgeted variable factory overhead for actual production. Actual production at a level above or below 100% of normal capacity. 18

Overhead Variance 19 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 23-3 (page 1056) Tip Top Corp. produced 3,000 units of product that required 2.5 standard hours per unit. The standard variable overhead cost per unit is $2.20 per hour. The actual variable factory overhead was $16,850. Determine the variable factory overhead controllable variance. 20

Example Exercise 23-3 (page 1056) $350 unfavorable Budgeted variable overhead cost = $2.20 x 3,000 units x 2.5 hours per unit = $16,500 $16,850 actual variable overhead cost - $16,500 budgeted variable overhead cost = $350 unfavorable 21

Overhead Variance Report Total actual factory overhead Total actual factory overhead –$22,400 Factory overhead applied Factory overhead applied – 4,000 hours x $6.00 per hour = $24,000 Total factory overhead cost variance Total factory overhead cost variance –$1,600 favorable 22

Example Exercise 23-4 (page 1058) Tip Top Corp. produced 3,000 units of product that required 2.5 standard hours per unit. The standard fixed overhead cost per unit is $0.90 per hour at 8,000 hours, which is 100% of normal capacity. Determine the fixed factory overhead volume variance. 23

Example Exercise 23-4 (page 1058) $450 unfavorable Budgeted fixed overhead hours = 8,000 hours Actual fixed overhead hours = 3,000 x 2.5 = 7,500 Fixed factory overhead volume variance = (8,000 – 7,500) x $0.90 = $450 24

Recording Variances Standard costs can be used solely as a management tool separate from the accounts in the general ledger. However, many companies include both standard costs and variances, in addition to actual costs, in their accounts. 25

Recording Variances 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. 26 Materials (7,300 sq. yds. X $5.00)36,500 Direct Materials Price Variance3,650 Accounts Payable (7,300 sq yds. X $5.50)40,150

Recording Variance 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. 27 Work in Process (7,500 sq. yds. X $5.00)37,500 Direct Materials Quantity Variance 1,000 Materials (7,300 sq yds. X $5.00)36,500

Questions? 28

One last thought…. Make sure you read through Chapter 24 before next week’s seminar. 29