1. 23 Performance Evaluation Using Variances from Standard Costs
C H A P T E R
Accounting
26e
Warren
Reeve
Duchac
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2. Standards are performance goals.
Standards (slide 1 of 2)
Standards are performance goals.
Manufacturing companies normally use standard cost for each of the three following product costs:
Direct materials
Direct labor
Factory overhead
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3. Standards (slide 2 of 2)
Accounting systems that use standards for product costs are called standard cost systems.
Standard cost systems enable management to determine the following:
How much a product should cost (standard cost)
How much it does cost (actual cost)
When actual costs are compared with standard costs, the exceptions or variances are reported.
This reporting by the principle of exceptions allows management to focus on correcting the cost variances.
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4. Setting Standards
The standard-setting process normally requires the joint efforts of accountants, engineers, and other management personnel.
The accountant converts the results of judgments and process studies into dollars and cents.
Engineers with the aid of operation managers identify the materials, labor, and machine requirements needed to produce the product.
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5. Types of Standards
Ideal standards, or theoretical standards, are standards that can be achieved only under perfect operating conditions, such as no idle time, no machine breakdowns, and no materials spoilage.
Currently attainable standards, sometimes called normal standards, are standards that can be attained with reasonable effort.
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6. Criticisms of Standard Costs
Some criticisms of using standard costs for performance evaluation include the following:
Standards limit operating improvements by discouraging improvement beyond the standard.
Standards are too difficult to maintain in a dynamic manufacturing environment, resulting in “stale standards.”
Standards can cause employees to lose sight of the larger objectives of the organization by focusing only on efficiency improvements.
Standards can cause employees to unduly focus on their own operations to the possible harm of other operations that rely on them.
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7. Budgetary Performance Evaluation (slide 1 of 2)
The budgetary performance evaluation compares the actual performance against the budget.
The standards for direct materials, direct labor, and factory overhead are separated into the following two components:
Standard price
Standard quantity
The standard cost per unit for direct materials, direct labor, and factory overhead is computed as follows:
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8. Budgetary Performance Evaluation (slide 2 of 2)
The master budget is prepared based on planned sales and production.
The budgeted costs for materials purchases, direct labor, and factory overhead are determined by multiplying their standard costs per unit by the planned level of production.
Budgeted (standard) costs are then compared to actual costs during the year for control purposes.
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9. Budget Performance Report
The differences between actual and standard costs are called costs variances.
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.
The report that summarizes actual costs, standard costs, and the differences for the units produced is called a budget performance report.
The budget performance report is based on actual production rather than planned production.
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10. Manufacturing Cost Variances (slide 1 of 4)
The total manufacturing cost variance is the difference between total standard costs and total actual cost for the units produced.
For control purposes, each product cost variance is separated into two additional variances.
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11. Manufacturing Cost Variances (slide 2 of 4)
The total direct materials variance is separated into a price and quantity variance.
This is because standard and actual direct materials costs are computed as follows:
Thus, the actual and standard direct materials costs may differ because of a price difference (variance), a quantity difference (variance), or both.
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12. Manufacturing Cost Variances (slide 3 of 4)
The total direct labor variance is separated into a rate and a time variance.
This is because standard and actual direct labor costs are computed as follows:
Therefore, the actual and standard direct labor costs may differ because of a rate difference (variance), a time difference (variance), or both.
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13. Manufacturing Cost Variances (slide 4 of 4)
The total factory overhead variance is separated into a controllable variance and a volume variance.
Because factory overhead has fixed and variable cost elements, it uses different variances than direct materials and direct labor, which are variable costs.
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14. Direct Materials Price Variance
The direct materials price variance is computed as follows:
If the actual price per unit exceeds the standard price per unit, the variance is unfavorable.
This positive amount (unfavorable variance) can be thought of as increasing costs (a debit).
If the actual price per unit is less than the standard price per unit, the variance is favorable.
This negative amount (favorable variance) can be thought of as decreasing costs (a credit).
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15. Direct Materials Quantity Variance
The direct materials quantity variance is computed as follows:
If the actual quantity for the units produced exceeds the standard quantity, the variance is unfavorable.
This positive amount (unfavorable variance) can be thought of as increasing costs (a debit).
If the actual quantity for the units produced is less than the standard quantity, the variance is favorable.
This negative amount (favorable variance) can be thought of as decreasing costs (a credit).
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16. Direct Labor Rate Variance
The direct labor rate variance is computed as follows:
If the actual rate per hour exceeds the standard rate per hour, the variance is unfavorable.
This positive amount (unfavorable variance) can be thought of as increasing costs (a debit).
If the actual rate per hour is less than the standard rate per hour, the variance is favorable.
This negative amount (favorable variance) can be thought of as decreasing costs (a credit).
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17. Direct Labor Time Variance
The direct labor time variance is computed as follows:
If the actual direct labor hours for the units produced exceeds the standard direct labor hours, the variance is unfavorable.
This positive amount (unfavorable variance) can be thought of as increasing costs (a debit).
If the actual direct labor hours for the units produced is less than the standard direct labor hours, the variance is favorable.
This negative amount (favorable variance) can be thought of as decreasing costs (a credit).
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18. Factory Overhead Variances
Factory overhead costs are analyzed differently than direct labor and materials costs.
This is because factory overhead costs have fixed and variable cost elements.
Factory overhead costs are budgeted and controlled by separating factory overhead into fixed and variable components.
Doing so allows the preparation of flexible budgets and the analysis of factory overhead controllable and volume variances.
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19. The Factory Overhead Flexible Budget (slide 1 of 2)
The budgeted factory overhead rate for Western Rider is computed as follows:
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20. The Factory Overhead Flexible Budget (slide 2 of 2)
For analysis purposes, the budgeted factory overhead rate is subdivided into a variable factory overhead rate and a fixed factory overhead rate. For Western Rider, the variable overhead rate and the fixed overhead rate are computed as follows:
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21. Variable Factory Overhead Controllable Variance (slide 1 of 2)
The variable factory overhead controllable variance is the difference between the actual variable overhead costs and the budgeted variable overhead for actual production.
The variable factory overhead controllable variance is computed as follows:
If the actual variable overhead is less than the budgeted variable overhead, the variance is favorable.
If the actual variable overhead exceeds the budgeted variable overhead, the variance is unfavorable.
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22. Variable Factory Overhead Controllable Variance (slide 2 of 2)
The budgeted variable factory overhead is the standard variable overhead for the actual units produced.
The budgeted variable factory overhead is computed as follows:
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23. Fixed Factory Overhead Volume Variance
The fixed factory overhead volume variance is the difference between the budgeted fixed overhead at 100% of normal capacity and the standard fixed overhead for the actual units produced.
The fixed factory overhead volume variance is computed as follows:
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24. Factory Overhead Cost Variance Report
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25. Factory Overhead Account (slide 1 of 3)
At the end of the period, the factory overhead account normally has a balance.
A debit balance in Factory Overhead represents underapplied overhead.
Underapplied overhead occurs when actual factory overhead costs exceed the applied factory overhead.
A credit balance in Factory Overhead represents overapplied overhead.
Overapplied overhead occurs when actual factory overhead costs are less than the applied factory overhead.
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26. Factory Overhead Account (slide 2 of 3)
The difference between the actual factory overhead and the applied factory overhead is the total factory overhead cost variance.
Thus, underapplied and overapplied factory overhead account balances represent the following total factory overhead cost variances:
Underapplied Factory Overhead = Unfavorable Total Factory Overhead Cost Variance
Overapplied Factory Overhead = Favorable Total Factory Overhead Cost Variance
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27. Factory Overhead Account (slide 3 of 3)
The variable factory overhead controllable variance and the volume variance can be computed by comparing the factory overhead account with the budgeted total overhead for the actual level produced.
The variable factory overhead controllable variance is the difference between the actual overhead incurred and the budgeted overhead.
If the actual factory overhead exceeds (is less than) the budgeted factory overhead, the controllable variance is unfavorable (favorable).
The variable factory overhead volume variance is the difference between the applied overhead and the budgeted overhead.
If the applied factory overhead is less than (exceeds) the budgeted factory overhead, the volume variance is unfavorable (favorable).
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28. Recording and Reporting Variances (slide 1 of 4)
Standard costs may be used as a management tool to control costs separately from the accounts in the general ledger.
However, many companies include standard costs in their accounts.
One method for doing so records sustained costs and variances at the same time the actual product costs are recorded.
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29. Recording and Reporting Variances (slide 2 of 4)
The journal entries to record the standard costs and variances for direct labor are similar to those for direct materials. These entries are summarized as follows:
Work in Process is debited for the standard cost of direct labor.
Wages Payable is credited for the actual direct labor cost incurred.
Direct Labor Rate Variance is debited for an unfavorable variance and credited for a favorable variance.
Direct Labor Time Variance is debited for an unfavorable variance and credited for a favorable variance.
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30. Recording and Reporting Variances (slide 3 of 4)
The factory overhead account already incorporates standard costs and variances into its journal entries.
Factory Overhead is debited for actual factory overhead and credited for applied (standard) factory overhead.
The ending balance of factory overhead (overapplied and underapplied) is the total factory overhead cost variance.
By comparing the actual factory overhead with the budgeted factory overhead, the controllable variance can be determined.
By comparing the budgeted factory overhead with the applied factory overhead, the volume variance can be determined.
When goods are completed, Finished Goods is debited and Work in Process is credited for the standard cost of the product transferred.
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31. Recording and Reporting Variances (slide 4 of 4)
At the end of the period, the balances of each of the variance accounts indicate the net favorable or unfavorable variance for the period. These variances may be reported in an income statement prepared for management’s use.
Variances are not reported to external users.
In preparing an income statement for external users, the balances of the variance accounts are normally transferred to Cost of Goods Sold.
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32. Variance from Standards in Income Statement
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33. Nonfinancial Performance Measures
A nonfinancial performance measure expresses performance in a measure other than dollars.
Such measures are often used to evaluate the time, quality, or quantity of a business activity.
Nonfinancial measures are often linked to either the inputs or outputs of an activity or process.
A process is a sequence of activities for performing a particular task.
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