1. Copyright © 2012 McGraw-Hill Ryerson Limited 10-1 PowerPoint Author: Robert G. Ducharme, MAcc, CA University of Waterloo, School of Accounting and Finance MANAGERIAL ACCOUNTING Ninth Canadian Edition GARRISON, CHESLEY, CARROLL, WEBB, LIBBY Standard Costs and Overhead Analysis Chapter 10

2. 10-2 Copyright © 2012 McGraw-Hill Ryerson Limited Standard Costs Standards are benchmarks or “norms” for measuring performance. Two types of standards are commonly used. Quantity standards specify how much of an input should be used to make a product or provide a service. Cost (price) standards specify how much should be paid for each unit of the input. LO 1

3. 10-3 Copyright © 2012 McGraw-Hill Ryerson Limited Standard Costs Direct Material Deviations from standards deemed significant are brought to the attention of management, a practice known as management by exception. Type of Product Cost Amount Direct Labour Manufacturing Overhead Standard LO 1

4. 10-4 Copyright © 2012 McGraw-Hill Ryerson Limited Variance Analysis Cycle Prepare standard cost performance report Analyze variances Begin Identify questions Receive explanations Take corrective actions Conduct next period’s operations Exhibit 10-1 LO 1

5. 10-5 Copyright © 2012 McGraw-Hill Ryerson Limited Accountants, engineers, purchasing agents, and production managers combine efforts to set standards that encourage efficient future production. Setting Standard Costs LO 1

6. 10-6 Copyright © 2012 McGraw-Hill Ryerson Limited Setting Standard Costs Should we use ideal standards that require employees to work at 100% peak efficiency? Engineer Managerial Accountant I recommend using practical standards that are currently attainable with reasonable and efficient effort. LO 1

7. 10-7 Copyright © 2012 McGraw-Hill Ryerson Limited Setting Direct Material Standards Standard Price per Unit Summarized in a Bill of Materials. Final, delivered cost of materials, net of discounts. Standard Quantity per Unit LO 1

8. 10-8 Copyright © 2012 McGraw-Hill Ryerson Limited Setting Standards Six Sigma advocates have sought to eliminate all defects and waste, rather than continually build them into standards. As a result allowances for waste and spoilage that are built into standards should be reduced over time. Six Sigma advocates have sought to eliminate all defects and waste, rather than continually build them into standards. As a result allowances for waste and spoilage that are built into standards should be reduced over time. LO 1

9. 10-9 Copyright © 2012 McGraw-Hill Ryerson Limited Setting Direct Labour Standards Standard Rate per Hour Often a single rate is used that reflects the mix of wages earned. Standard Hours per Unit Use time and motion studies for each labour operation. LO 1

10. 10-10 Copyright © 2012 McGraw-Hill Ryerson Limited Setting Variable Overhead Standards Price Standards The rate is the variable portion of the predetermined overhead rate. Quantity Standards The quantity is the activity in the allocation base used to calculate the predetermined overhead. LO 1

11. 10-11 Copyright © 2012 McGraw-Hill Ryerson Limited Standard Cost Card – Variable Production Cost A standard cost card for one unit of product might look like this: LO 1

12. 10-12 Copyright © 2012 McGraw-Hill Ryerson Limited Are standards the same as budgets? A budget is set for total costs. Standards vs. Budgets A standard is a per unit cost. Standards are often used when preparing budgets. LO 1

13. 10-13 Copyright © 2012 McGraw-Hill Ryerson Limited Price and Quantity Standards Price and quantity standards are determined separately for two reasons:  The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used.  The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production. LO 1

14. 10-14 Copyright © 2012 McGraw-Hill Ryerson Limited A General Model for Variance Analysis Variance Analysis Price Variance Difference between actual price and standard price Quantity Variance Difference between actual quantity and standard quantity LO 1

15. 10-15 Copyright © 2012 McGraw-Hill Ryerson Limited Variance Analysis Price VarianceQuantity Variance Materials price variance Labour rate variance VOH spending variance Materials quantity variance Labour efficiency variance VOH efficiency variance A General Model for Variance Analysis LO 1

16. 10-16 Copyright © 2012 McGraw-Hill Ryerson Limited Price VarianceQuantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price A General Model for Variance Analysis LO 1 Spending Variance

17. 10-17 Copyright © 2012 McGraw-Hill Ryerson Limited Price VarianceQuantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price A General Model for Variance Analysis LO 1 Spending Variance Actual quantity is the amount of direct materials, direct labour, and variable manufacturing overhead actually used.

18. 10-18 Copyright © 2012 McGraw-Hill Ryerson Limited Price VarianceQuantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price A General Model for Variance Analysis LO 1 Spending Variance Standard quantity is the standard quantity allowed for the actual output of the period.

19. 10-19 Copyright © 2012 McGraw-Hill Ryerson Limited Price VarianceQuantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price A General Model for Variance Analysis LO 1 Spending Variance Actual price is the amount actually paid for the input used.

20. 10-20 Copyright © 2012 McGraw-Hill Ryerson Limited Price VarianceQuantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price A General Model for Variance Analysis LO 1 Spending Variance Standard price is the amount that should have been paid for the input used.

21. 10-21 Copyright © 2012 McGraw-Hill Ryerson Limited Price VarianceQuantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price A General Model for Variance Analysis LO 1 Spending Variance (AQ × AP) – (AQ × SP) (AQ × SP) – (SQ × SP) AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity

22. 10-22 Copyright © 2012 McGraw-Hill Ryerson Limited Glacier Peak Outfitters has the following direct material standard for the fibrefill in its mountain parka. 0.1 kg. of fibrefill per parka at $5.00 per kg. Last month 210 kgs of fibrefill were purchased and used to make 2,000 parkas. The material cost a total of $1,029. Material Variances Example LO 2

23. 10-23 Copyright © 2012 McGraw-Hill Ryerson Limited 210 kgs. 210 kgs. 200 kgs. × × × $4.90 per kg. $5.00 per kg. $5.00 per kg. = $1,029 = $1,050 = $1,000 Price variance $21 favourable Quantity variance $50 unfavourable Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Material Variances Summary LO 2 $29 unfavourable

24. 10-24 Copyright © 2012 McGraw-Hill Ryerson Limited 210 kgs. 210 kgs. 200 kgs. × × × $4.90 per kg. $5.00 per kg. $5.00 per kg. = $1,029 = $1,050 = $1,000 Price variance $21 favourable Quantity variance $50 unfavourable Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price $1,029  210 kgs = $4.90 per kg Material Variances Summary LO 2 $29 unfavourable

25. 10-25 Copyright © 2012 McGraw-Hill Ryerson Limited 210 kgs. 210 kgs. 200 kgs. × × × $4.90 per kg. $5.00 per kg. $5.00 per kg. = $1,029 = $1,050 = $1,000 Price variance $21 favourable Quantity variance $50 unfavourable Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 0.1 kg per parka  2,000 parkas = 200 kgs Material Variances Summary LO 2 $29 unfavourable

26. 10-26 Copyright © 2012 McGraw-Hill Ryerson Limited Material Variances: Using the Factored Equations Materials price variance MPV = AQ (AP – SP) = 210 kgs ($4.90/kg – $5.00/kg) = 210 kgs (-$0.10/kg) = $21 F Materials quantity variance MQV = SP (AQ – SQ) = $5.00/kg (210 kgs – (0.1 kg/parka  2,000 parkas)) = $5.00/kg (210 kgs – 200 kgs) = $5.00/kg (10 kgs) = $50 U LO 2

27. 10-27 Copyright © 2012 McGraw-Hill Ryerson Limited Materials Price VarianceMaterials Quantity Variance Production Manager Purchasing Manager The standard price is used to compute the quantity variance so that the production manager is not held responsible for the purchasing manager’s performance. Responsibility for Material Variances LO 2

28. 10-28 Copyright © 2012 McGraw-Hill Ryerson Limited I am not responsible for this unfavourable material quantity variance. You purchased cheap material, so my people had to use more of it. Your poor scheduling sometimes requires me to rush order material at a higher price, causing unfavourable price variances. Responsibility for Material Variances LO 2

29. 10-29 Copyright © 2012 McGraw-Hill Ryerson Limited Hanson Inc. has the following direct material standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound Last week, 1,700 pounds of material were purchased and used to make 1,000 Zippies. The material cost a total of $6,630. Zippy Quick Check LO 2

30. 10-30 Copyright © 2012 McGraw-Hill Ryerson Limited Quick Check Zippy Hanson’s material price variance (MPV) for the week was: a.$170 unfavourable. b.$170 favourable. c.$800 unfavourable. d.$800 favourable. Hanson’s material price variance (MPV) for the week was: a.$170 unfavourable. b.$170 favourable. c.$800 unfavourable. d.$800 favourable. LO 2

31. 10-31 Copyright © 2012 McGraw-Hill Ryerson Limited Hanson’s material price variance (MPV) for the week was: a.$170 unfavourable. b.$170 favourable. c.$800 unfavourable. d.$800 favourable. Hanson’s material price variance (MPV) for the week was: a.$170 unfavourable. b.$170 favourable. c.$800 unfavourable. d.$800 favourable. MPV = AQ (AP – SP) MPV = 1,700 lbs. × ($3.90 – 4.00) MPV = $170 favourable Quick Check Zippy LO 2

32. 10-32 Copyright © 2012 McGraw-Hill Ryerson Limited Quick Check Hanson’s material quantity variance (MQV) for the week was: a.$170 unfavourable. b.$170 favourable. c.$800 unfavourable. d.$800 favourable. Hanson’s material quantity variance (MQV) for the week was: a.$170 unfavourable. b.$170 favourable. c.$800 unfavourable. d.$800 favourable. Zippy LO 2

33. 10-33 Copyright © 2012 McGraw-Hill Ryerson Limited Hanson’s material quantity variance (MQV) for the week was: a.$170 unfavourable. b.$170 favourable. c.$800 unfavourable. d.$800 favourable. Hanson’s material quantity variance (MQV) for the week was: a.$170 unfavourable. b.$170 favourable. c.$800 unfavourable. d.$800 favourable. MQV = SP (AQ – SQ) MQV = $4.00 × (1,700 lbs – 1,500 lbs) MQV = $800 unfavourable Quick Check Zippy LO 2

34. 10-34 Copyright © 2012 McGraw-Hill Ryerson Limited 1,700 lbs. 1,700 lbs. 1,500 lbs. × × × $3.90 per lb. $4.00 per lb. $4.00 per lb. = $6,630 = $ 6,800 = $6,000 Price variance $170 favourable Quantity variance $800 unfavourable Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Zippy Quick Check LO 2 $630 unfavourable

35. 10-35 Copyright © 2012 McGraw-Hill Ryerson Limited Isolation of Material Variances I need the price variance sooner so that I can better identify purchasing problems. You accountants just don’t understand the problems that purchasing managers have. I’ll start computing the price variance when material is purchased rather than when it’s used. LO 2

36. 10-36 Copyright © 2012 McGraw-Hill Ryerson Limited Material Variances Hanson purchased and used 1,700 pounds. How are the variances computed if the amount purchased differs from the amount used? The price variance is computed on the entire quantity purchased. The quantity variance is computed only on the quantity used. LO 2

37. 10-37 Copyright © 2012 McGraw-Hill Ryerson Limited Hanson Inc. has the following material standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound Last week, 2,800 pounds of material were purchased at a total cost of $10,920, and 1,700 pounds were used to make 1,000 Zippies. Zippy Quick Check Continued LO 2

38. 10-38 Copyright © 2012 McGraw-Hill Ryerson Limited Actual Quantity Actual Quantity Purchased Purchased × × Actual Price Standard Price 2,800 lbs. 2,800 lbs. × × $3.90 per lb. $4.00 per lb. = $10,920 = $11,200 Price variance $280 favourable Price variance increases because quantity purchased increases. Zippy Quick Check Continued LO 2

39. 10-39 Copyright © 2012 McGraw-Hill Ryerson Limited Actual Quantity Used Standard Quantity × × Standard Price Standard Price 1,700 lbs. 1,500 lbs. × × $4.00 per lb. $4.00 per lb. = $6,800 = $6,000 Quantity variance $800 unfavourable Quantity variance is unchanged because actual and standard quantities are unchanged. Zippy Quick Check Continued LO 2

40. 10-40 Copyright © 2012 McGraw-Hill Ryerson Limited Glacier Peak Outfitters has the following direct labour standard for its mountain parka. 1.2 standard hours per parka at $10.00 per hour Last month, employees actually worked 2,500 hours at a total labour cost of $26,250 to make 2,000 parkas. Labour Variances Example LO 3

41. 10-41 Copyright © 2012 McGraw-Hill Ryerson Limited 2,500 hours 2,500 hours 2,400 hours × × × $10.50 per hour $10.00 per hour $10.00 per hour = $26,250 = $25,000 = $24,000 Rate variance $1,250 unfavourable Efficiency variance $1,000 unfavourable Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate Labour Variances Summary LO 3 $2,250 unfavourable

42. 10-42 Copyright © 2012 McGraw-Hill Ryerson Limited Labour Variances Summary 2,500 hours 2,500 hours 2,400 hours × × × $10.50 per hour $10.00 per hour $10.00 per hour = $26,250 = $25,000 = $24,000 Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate $26,250  2,500 hours = $10.50 per hour Rate variance $1,250 unfavourable Efficiency variance $1,000 unfavourable LO 3 $2,250 unfavourable

43. 10-43 Copyright © 2012 McGraw-Hill Ryerson Limited Labour Variances Summary 2,500 hours 2,500 hours 2,400 hours × × × $10.50 per hour $10.00 per hour $10.00 per hour = $26,250 = $25,000 = $24,000 Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 1.2 hours per parka  2,000 parkas = 2,400 hours Rate variance $1,250 unfavourable Efficiency variance $1,000 unfavourable LO 3 $2,250 unfavourable

44. 10-44 Copyright © 2012 McGraw-Hill Ryerson Limited Labour Variances: Using the Factored Equations Labour rate variance LRV = AH (AR – SR) = 2,500 hours ($10.50 per hour – $10.00 per hour) = 2,500 hours ($0.50 per hour) = $1,250 unfavourable Labour efficiency variance LEV = SR (AH – SH) = $10.00 per hour (2,500 hours – 2,400 hours) = $10.00 per hour (100 hours) = $1,000 unfavourable LO 3

45. 10-45 Copyright © 2012 McGraw-Hill Ryerson Limited Responsibility for Labour Variances Production Manager Production managers are usually held accountable for labour variances because they can influence the: Mix of skill levels assigned to work tasks. Level of employee motivation. Quality of production supervision. Quality of training provided to employees. LO 3

46. 10-46 Copyright © 2012 McGraw-Hill Ryerson Limited Responsibility for Labour Variances I am not responsible for the unfavourable labour efficiency variance! You purchased cheap material, so it took more time to process it. I think it took more time to process the materials because the Maintenance Department has poorly maintained your equipment. LO 3

47. 10-47 Copyright © 2012 McGraw-Hill Ryerson Limited Hanson Inc. has the following direct labour standard to manufacture one Zippy: 1.5 standard hours per Zippy at $12.00 per direct labour hour Last week, 1,550 direct labour hours were worked at a total labour cost of $18,910 to make 1,000 Zippies. Zippy Quick Check LO 3

48. 10-48 Copyright © 2012 McGraw-Hill Ryerson Limited Hanson’s labour rate variance (LRV) for the week was: a. $310 unfavourable. b. $310 favourable. c. $300 unfavourable. d. $300 favourable. Hanson’s labour rate variance (LRV) for the week was: a. $310 unfavourable. b. $310 favourable. c. $300 unfavourable. d. $300 favourable. Quick Check Zippy LO 3

49. 10-49 Copyright © 2012 McGraw-Hill Ryerson Limited Hanson’s labour rate variance (LRV) for the week was: a. $310 unfavourable. b. $310 favourable. c. $300 unfavourable. d. $300 favourable. Hanson’s labour rate variance (LRV) for the week was: a. $310 unfavourable. b. $310 favourable. c. $300 unfavourable. d. $300 favourable. Quick Check LRV = AH (AR – SR) LRV = 1,550 hrs × ($12.20 – $12.00) LRV = $310 unfavourable Zippy LO 3

50. 10-50 Copyright © 2012 McGraw-Hill Ryerson Limited Hanson’s labour efficiency variance (LEV) for the week was: a. $590 unfavourable. b. $590 favourable. c. $600 unfavourable. d. $600 favourable. Hanson’s labour efficiency variance (LEV) for the week was: a. $590 unfavourable. b. $590 favourable. c. $600 unfavourable. d. $600 favourable. Quick Check Zippy LO 3

51. 10-51 Copyright © 2012 McGraw-Hill Ryerson Limited Hanson’s labour efficiency variance (LEV) for the week was: a. $590 unfavourable. b. $590 favourable. c. $600 unfavourable. d. $600 favourable. Hanson’s labour efficiency variance (LEV) for the week was: a. $590 unfavourable. b. $590 favourable. c. $600 unfavourable. d. $600 favourable. Quick Check LEV = SR (AH – SH) LEV = $12.00 × (1,550 hrs – 1,500 hrs) LEV = $600 unfavourable Zippy LO 3

52. 10-52 Copyright © 2012 McGraw-Hill Ryerson Limited Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate Rate variance $310 unfavourable Efficiency variance $600 unfavourable 1,550 hours 1,550 hours 1,500 hours × × × $12.20 per hour $12.00 per hour $12.00 per hour = $18,910 = $18,600 = $18,000 Zippy Quick Check LO 3 $910 unfavourable

53. 10-53 Copyright © 2012 McGraw-Hill Ryerson Limited Glacier Peak Outfitters has the following direct variable manufacturing overhead labour standard for its mountain parka. 1.2 standard hours per parka at $4.00 per hour Last month, employees actually worked 2,500 hours to make 2,000 parkas. Actual variable manufacturing overhead for the month was $10,500. Variable Manufacturing Overhead Variances Example LO 4

54. 10-54 Copyright © 2012 McGraw-Hill Ryerson Limited 2,500 hours 2,500 hours 2,400 hours × × × $4.20 per hour $4.00 per hour $4.00 per hour = $10,500 = $10,000 = $9,600 Spending variance $500 unfavourable Efficiency variance $400 unfavourable Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate Variable Manufacturing Overhead Variances Summary LO 4 $900 unfavourable

55. 10-55 Copyright © 2012 McGraw-Hill Ryerson Limited Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours 2,500 hours 2,400 hours × × × $4.20 per hour $4.00 per hour $4.00 per hour = $10,500 = $10,000 = $9,600 Spending variance $500 unfavourable Efficiency variance $400 unfavourable $10,500  2,500 hours = $4.20 per hour Variable Manufacturing Overhead Variances Summary LO 4 $900 unfavourable

56. 10-56 Copyright © 2012 McGraw-Hill Ryerson Limited Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours 2,500 hours 2,400 hours × × × $4.20 per hour $4.00 per hour $4.00 per hour = $10,500 = $10,000 = $9,600 Spending variance $500 unfavourable Efficiency variance $400 unfavourable 1.2 hours per parka  2,000 parkas = 2,400 hours Variable Manufacturing Overhead Variances Summary LO 4 $900 unfavourable

57. 10-57 Copyright © 2012 McGraw-Hill Ryerson Limited Variable Manufacturing Overhead Variances: Using Factored Equations Variable manufacturing overhead spending variance VMSV = AH (AR – SR) = 2,500 hours ($4.20 per hour – $4.00 per hour) = 2,500 hours ($0.20 per hour) = $500 unfavourable Variable manufacturing overhead efficiency variance VMEV = SR (AH – SH) = $4.00 per hour (2,500 hours – 2,400 hours) = $4.00 per hour (100 hours) = $400 unfavourable LO 4

58. 10-58 Copyright © 2012 McGraw-Hill Ryerson Limited Hanson Inc. has the following variable manufacturing overhead standard to manufacture one Zippy: 1.5 standard hours per Zippy at $3.00 per direct labour hour Last week, 1,550 hours were worked to make 1,000 Zippies, and $5,115 was spent for variable manufacturing overhead. Zippy Quick Check LO 4

59. 10-59 Copyright © 2012 McGraw-Hill Ryerson Limited Hanson’s spending variance (VOSV) for variable manufacturing overhead for the week was: a.$465 unfavourable. b.$400 favourable. c.$335 unfavourable. d.$300 favourable. Hanson’s spending variance (VOSV) for variable manufacturing overhead for the week was: a.$465 unfavourable. b.$400 favourable. c.$335 unfavourable. d.$300 favourable. Quick Check Zippy LO 4

60. 10-60 Copyright © 2012 McGraw-Hill Ryerson Limited Hanson’s spending variance (VOSV) for variable manufacturing overhead for the week was: a.$465 unfavourable. b.$400 favourable. c.$335 unfavourable. d.$300 favourable. Hanson’s spending variance (VOSV) for variable manufacturing overhead for the week was: a.$465 unfavourable. b.$400 favourable. c.$335 unfavourable. d.$300 favourable. Quick Check VOSV = AH (AR – SR) VOSV = 1,550 hrs × ($3.30 – $3.00) VOSV = $465 unfavourable Zippy LO 4

61. 10-61 Copyright © 2012 McGraw-Hill Ryerson Limited Hanson’s efficiency variance (VOEV) for variable manufacturing overhead for the week was: a.$435 unfavourable. b.$435 favourable. c.$150 unfavourable. d.$150 favourable. Hanson’s efficiency variance (VOEV) for variable manufacturing overhead for the week was: a.$435 unfavourable. b.$435 favourable. c.$150 unfavourable. d.$150 favourable. Quick Check Zippy LO 4

62. 10-62 Copyright © 2012 McGraw-Hill Ryerson Limited Hanson’s efficiency variance (VOEV) for variable manufacturing overhead for the week was: a.$435 unfavourable. b.$435 favourable. c.$150 unfavourable. d.$150 favourable. Hanson’s efficiency variance (VOEV) for variable manufacturing overhead for the week was: a.$435 unfavourable. b.$435 favourable. c.$150 unfavourable. d.$150 favourable. Quick Check VOEV = SR (AH – SH) VOEV = $3.00 × (1,550 hrs – 1,500 hrs) VOEV = $150 unfavourable 1,000 units × 1.5 hrs per unit Zippy LO 4

63. 10-63 Copyright © 2012 McGraw-Hill Ryerson Limited Spending variance $465 unfavourable Efficiency variance $150 unfavourable 1,550 hours 1,550 hours 1,500 hours × × × $3.30 per hour $3.00 per hour $3.00 per hour = $5,115 = $4,650 = $4,500 Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate Zippy Quick Check LO 4 $615 unfavourable

64. 10-64 Copyright © 2012 McGraw-Hill Ryerson Limited Overhead Rates and Overhead Analysis Overhead from the flexible budget for the denominator level of activity POHR = Recall that overhead costs are assigned to products and services using a predetermined overhead rate (POHR): Assigned Overhead = POHR × Standard Activity Denominator level of activity LO 5

65. 10-65 Copyright © 2012 McGraw-Hill Ryerson Limited The predetermined overhead rate can be broken down into fixed and variable components. The variable component is useful for preparing and analyzing variable overhead variances. The fixed component is useful for preparing and analyzing fixed overhead variances. Overhead Rates and Overhead Analysis LO 5

66. 10-66 Copyright © 2012 McGraw-Hill Ryerson Limited Normal versus Standard Cost Systems In a normal cost system, overhead is applied to work in process based on the actual number of hours worked in the period. In a standard cost system, overhead is applied to work in process based on the standard hours allowed for the actual output of the period. LO 6

67. 10-67 Copyright © 2012 McGraw-Hill Ryerson Limited Budget Variance Volume Variance FR = Standard Fixed Overhead Rate SH = Standard Hours Allowed DH = Denominator Hours SH × FR Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied DH × FR Fixed Overhead Variances LO 6

68. 10-68 Copyright © 2012 McGraw-Hill Ryerson Limited ColaCo prepared this budget for overhead: Overhead Rates and Overhead Analysis – Example TotalVariableTotalFixed MachineVariableOverheadFixedOverhead HoursOverheadRateOverheadRate 3,0006,000$?9,000$? 4,0008,000?9,000? ColaCo applies overhead based on machine-hour activity. Let’s calculate overhead rates. LO 6

69. 10-69 Copyright © 2012 McGraw-Hill Ryerson Limited Rate = Total Variable Overhead ÷ Machine Hours This rate is constant at all levels of activity. TotalVariableTotalFixed MachineVariableOverheadFixedOverhead HoursOverheadRateOverheadRate 3,000 6,000$ 2.00$ 9,000$ ? 4,000 8,000 2.00 9,000 ? ColaCo prepared this budget for overhead: Overhead Rates and Overhead Analysis – Example LO 6

70. 10-70 Copyright © 2012 McGraw-Hill Ryerson Limited TotalVariableTotalFixed MachineVariableOverheadFixedOverhead HoursOverheadRateOverheadRate 3,000 6,000$ 2.00$ 9,000$ 3.00$ 4,000 8,000 2.00 9,000 2.25 Rate = Total Fixed Overhead ÷ Machine Hours This rate decreases when activity increases. ColaCo prepared this budget for overhead: Overhead Rates and Overhead Analysis – Example LO 6

71. 10-71 Copyright © 2012 McGraw-Hill Ryerson Limited TotalVariableTotalFixed MachineVariableOverheadFixedOverhead HoursOverheadRateOverheadRate 3,000 6,000$ 2.00$ 9,000$ 3.00$ 4,000 8,000 2.00 9,000 2.25 The total POHR is the sum of the fixed and variable rates for a given activity level. ColaCo prepared this budget for overhead: Overhead Rates and Overhead Analysis – Example LO 6

72. 10-72 Copyright © 2012 McGraw-Hill Ryerson Limited ColaCo’s actual production required 3,200 standard machine hours. Actual fixed overhead was $8,450. The predetermined overhead rate is based on 3,000 machine hours. Fixed Overhead Variances – Example LO 6

73. 10-73 Copyright © 2012 McGraw-Hill Ryerson Limited Overhead Variances Now let’s turn our attention to calculating fixed overhead variances. LO 6

74. 10-74 Copyright © 2012 McGraw-Hill Ryerson Limited Fixed Overhead Variances – Example Budget variance $550 favourable $8,450$9,000 Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied LO 6

75. 10-75 Copyright © 2012 McGraw-Hill Ryerson Limited Fixed Overhead Variances – A Closer Look Budget Variance Results from spending more or less than expected for fixed overhead items. Now, let’s use the standard hours allowed to compute the fixed overhead volume variance. LO 6

76. 10-76 Copyright © 2012 McGraw-Hill Ryerson Limited 3,200 hours × $3.00 per hour Budget variance $550 favourable Fixed Overhead Variances – Example $8,450$9,000$9,600 Volume variance $600 favourable SH × FR Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied LO 6 $1,150 favourable

77. 10-77 Copyright © 2012 McGraw-Hill Ryerson Limited Volume Variance – A Closer Look Volume Variance Results when standard hours allowed for actual output differs from the denominator activity. Unfavourable when standard hours < denominator hours Favourable when standard hours > denominator hours LO 6

78. 10-78 Copyright © 2012 McGraw-Hill Ryerson Limited Volume Variance – A Closer Look Volume Variance Results when standard hours allowed for actual output differs from the denominator activity. Unfavourable when standard hours < denominator hours Favourable when standard hours > denominator hours Does not measure over- or under spending It results from treating fixed overhead as if it were a variable cost. LO 6

79. 10-79 Copyright © 2012 McGraw-Hill Ryerson Limited Quick Check Yoder Enterprises’ actual production for the period required 2,100 standard direct labour hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labour hour. What was the budget variance? a. $350 U b. $350 F c. $100 F d. $100 U Yoder Enterprises’ actual production for the period required 2,100 standard direct labour hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labour hour. What was the budget variance? a. $350 U b. $350 F c. $100 F d. $100 U LO 6

80. 10-80 Copyright © 2012 McGraw-Hill Ryerson Limited Yoder Enterprises’ actual production for the period required 2,100 standard direct labour hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labour hour. What was the budget variance? a. $350 U b. $350 F c. $100 F d. $100 U Yoder Enterprises’ actual production for the period required 2,100 standard direct labour hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labour hour. What was the budget variance? a. $350 U b. $350 F c. $100 F d. $100 U Quick Check Budget variance = Actual fixed overhead – Budgeted fixed overhead = $14,800 – $14,450 = $350 U LO 6

81. 10-81 Copyright © 2012 McGraw-Hill Ryerson Limited Quick Check Yoder Enterprises’ actual production for the period required 2,100 standard direct labour hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labour hour. What was the volume variance? a. $250 U b. $250 F c. $100 F d. $100 U Yoder Enterprises’ actual production for the period required 2,100 standard direct labour hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labour hour. What was the volume variance? a. $250 U b. $250 F c. $100 F d. $100 U LO 6

82. 10-82 Copyright © 2012 McGraw-Hill Ryerson Limited Yoder Enterprises’ actual production for the period required 2,100 standard direct labour hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labour hour. What was the volume variance? a. $250 U b. $250 F c. $100 F d. $100 U Yoder Enterprises’ actual production for the period required 2,100 standard direct labour hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labour hour. What was the volume variance? a. $250 U b. $250 F c. $100 F d. $100 U Quick Check Volume variance = Budgeted fixed overhead – (SH  FR) = $14,450 – (2,100 hours  $7 per hour) = $14,450 – $14,700 = $250 F LO 6

83. 10-83 Copyright © 2012 McGraw-Hill Ryerson Limited 2,100 hours × $7.00 per hour Budget variance $350 unfavourable $14,800$14,450 $14,700 Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied Volume variance $250 favourable SH × FR Quick Check Summary LO 6 $1,150 favourable

84. 10-84 Copyright © 2012 McGraw-Hill Ryerson Limited Fixed Overhead Variances – A Graphic Approach Let’s look at a graph showing fixed overhead variances. We will use ColaCo’s numbers from the previous example. LO 6

85. 10-85 Copyright © 2012 McGraw-Hill Ryerson Limited Activity Cost 3,000 Hours Expected Activity $9,000 budgeted fixed OH Fixed overhead applied to products Fixed Overhead Variances – A Graphic Approach LO 6

86. 10-86 Copyright © 2012 McGraw-Hill Ryerson Limited $8,450 actual fixed OH Activity Cost 3,000 Hours Expected Activity $9,000 budgeted fixed OH Fixed overhead applied to products $8,450 actual fixed OH $550 Favourable Budget Variance { Fixed Overhead Variances – A Graphic Approach LO 6

87. 10-87 Copyright © 2012 McGraw-Hill Ryerson Limited { $8,450 actual fixed OH 3,200 machine hours × $3.00 fixed overhead rate $600 Favourable Volume Variance $9,600 applied fixed OH 3,200 Standard Hours Activity Cost 3,000 Hours Expected Activity $9,000 budgeted fixed OH Fixed overhead applied to products $550 Favourable Budget Variance { $8,450 actual fixed OH Fixed Overhead Variances – A Graphic Approach LO 6

88. 10-88 Copyright © 2012 McGraw-Hill Ryerson Limited Overhead Variances and Under- or Overapplied Overhead Cost In a standard cost system: Unfavourable variances are equivalent to underapplied overhead. Favourable variances are equivalent to overapplied overhead. The sum of the overhead variances equals the under- or overapplied overhead cost for a period. LO 6

89. 10-89 Copyright © 2012 McGraw-Hill Ryerson Limited Theoretical capacity is the volume of capacity if all available production time is used and no waste occurs. (i.e. operations conducted 24 hours per day, 7 days per week, 365 days per year, with no downtime) Theoretical vs. Practical Capacity Practical capacity represents what could be produced with operations at theoretical capacity less unavoidable downtime. LO 7

90. 10-90 Copyright © 2012 McGraw-Hill Ryerson Limited Variance Analysis and Management by Exception How do I know which variances to investigate? Larger variances, in dollar amount or as a percentage of the standard, are investigated first. LO 7

91. 10-91 Copyright © 2012 McGraw-Hill Ryerson Limited A Statistical Control Chart 123456789 Variance Measurements Favourable Limit Unfavourable Limit Warning signals for investigation Desired Value Exhibit 10-9 LO 7

92. 10-92 Copyright © 2012 McGraw-Hill Ryerson Limited Advantages of Standard Costs Management by exception Advantages Promotes economy and efficiency Simplified bookkeeping Enhances responsibility accounting LO 7

93. 10-93 Copyright © 2012 McGraw-Hill Ryerson Limited Potential Problems Emphasis on negative may impact morale. Emphasizing standards may exclude other important objectives. Favourable variances may be misinterpreted. Continuous improvement may be more important than meeting standards. Standard cost reports may not be timely. Invalid assumptions about the relationship between labour cost and output. Potential Problems with Standard Costs LO 7

94. 10-94 Copyright © 2012 McGraw-Hill Ryerson Limited Appendix 10A Further Analysis of Materials Variances LO 8

95. 10-95 Copyright © 2012 McGraw-Hill Ryerson Limited Appendix 10A – Further Analysis of Materials Variances: Mix and Yield When the production process requires the input of more than one material, the material quantity variance (MQV) can be further broken down into mix variance and yield variance. LO 8

96. 10-96 Copyright © 2012 McGraw-Hill Ryerson Limited Appendix 10A – Mix and Yield Variances SP (AQ – M) SP (M – SQ) AQ = Actual Quantity M = AQ @ Std. Mix SP = Standard Price SQ = Standard Quantity Mix VarianceYield Variance Actual Quantity Actual Quantity Standard Quantity @ Std. Mix (M) × × × Standard Price Standard Price Standard Price Material Quantity Variance LO 8

97. 10-97 Copyright © 2012 McGraw-Hill Ryerson Limited Appendix 10A – Example of Mix and Yield Variances  One unit of finished goods requires the following input mix:  2 kgs of A with a standard price of $1.50/kg  3 kgs of B with a standard price of $2.50/kg  The standard mix is thus 2A:3B  During the period, 150 units of finished goods were produced using 350 kgs of A and 450 kgs of B. LO 8

98. 10-98 Copyright © 2012 McGraw-Hill Ryerson Limited Appendix 10A – Mix and Yield Variances  Mix Variance: SP(AQ – M) Material A: $1.50 × [350 – 2/5 (350 + 450)] = $45 U Material B: $2.50 × [450 – 3/5 (350 + 450)] = $75 F  Yield Variance: SP(M – SQ) Material A: $1.50 × [ 2/5 (350 + 450) – 150 (2)] = $30 U Material B: $2.50 × [ 3/5 (350 + 450) – 150 (3)] = $75 U  Material Quantity Variance: SP(AQ – SQ) Material A: $1.50 × [350 – 150 (2)] = $75 U Material B: $2.50 × [450 – 150 (3)] = $-0- U LO 8

99. 10-99 Copyright © 2012 McGraw-Hill Ryerson Limited Appendix 10A – Material Mix and Yield Variances LO 8

100. 10-100 Copyright © 2012 McGraw-Hill Ryerson Limited Appendix 10B General Ledger Entries to Record Variances LO 9

101. 10-101 Copyright © 2012 McGraw-Hill Ryerson Limited Appendix 10B Journal Entries to Record Variances We will use information from the Glacier Peak Outfitters example presented earlier in the chapter to illustrate journal entries for standard cost variances. Recall the following: Material AQ × AP = $1,029 AQ × SP = $1,050 SQ × SP = $1,000 MPV = $21 F MQV = $50 U Material AQ × AP = $1,029 AQ × SP = $1,050 SQ × SP = $1,000 MPV = $21 F MQV = $50 U Labour AH × AR = $26,250 AH × SR = $25,000 SH × SR = $24,000 LRV = $1,250 U LEV = $1,000 U Labour AH × AR = $26,250 AH × SR = $25,000 SH × SR = $24,000 LRV = $1,250 U LEV = $1,000 U Now, let’s prepare the entries to record the labour and material variances. LO 9

102. 10-102 Copyright © 2012 McGraw-Hill Ryerson Limited Appendix 10B Recording Material Variances LO 9

103. 10-103 Copyright © 2012 McGraw-Hill Ryerson Limited Appendix 10B Recording Labour Variances LO 9

104. 10-104 Copyright © 2012 McGraw-Hill Ryerson Limited Variable manufacturing overhead variances are usually not recorded in the accounts separately, but are determined as part of the general analysis of overhead. Appendix 10B – Recording Variable Manufacturing Overhead Variances LO 9

105. 10-105 Copyright © 2012 McGraw-Hill Ryerson Limited Appendix 10B Cost Flows in a Standard Cost System  Inventories are recorded at standard cost.  Variances are recorded as follows:  Favourable variances are credits, representing savings in production costs.  Unfavourable variances are debits, representing excess production costs.  Standard cost variances are usually closed to cost of goods sold.  Unfavourable variances increase cost of goods sold.  Favourable variances decrease cost of goods sold.  Inventories are recorded at standard cost.  Variances are recorded as follows:  Favourable variances are credits, representing savings in production costs.  Unfavourable variances are debits, representing excess production costs.  Standard cost variances are usually closed to cost of goods sold.  Unfavourable variances increase cost of goods sold.  Favourable variances decrease cost of goods sold. LO 9

106. 10-106 Copyright © 2012 McGraw-Hill Ryerson Limited End of Chapter 10