Performance Evaluation Using Variances from Standard Costs

1. Cost Behavior and Cost-Volume-Profit Analysis Performance Evaluation Using Variances from Standard Costs Performance Evaluation Using Variances from Standard Costs Chapter 22

2. Learning Objective 1 Describe the types of standards and how they are established.

3. Standards Standards are performance goals. Manufacturing companies normally use standard cost for each of these three product costs: Direct materials Direct labor Factory overhead LO 1

4. Standards Accounting systems that use standards for product costs are called standard costsystems. Standard cost systems enable management to determine: How much a product should cost (standard cost) How much it does cost (actual cost) LO 1

5. When actual costs are compared with standard costs, only the exceptions or variances are reported for cost control. This reporting by the principle of exceptions allows management to focus on correcting the cost variances. LO 1 Standards

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

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

8. Currently attainable standards, sometimes called normal standards, can be attained with reasonable effort. Such standards, which are used by most companies, allow for normal production difficulties and mistakes. LO 1 Types of Standards

9. Standard costs should be periodically reviewed to ensure that they reflect current operating conditions. Standards should not be revised, however, just because they differ from actual costs. LO 1 Reviewing and Revising Standards

10. Learning Objective 2 Describe and illustrate how standards are used in budgeting.

11. Budgetary Performance Evaluation 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 x = LO 2

12. Budget Performance Report The report that summarizes actual costs, standard costs, and the differences for the units produced is called a budget performance report. The differences between actual and standard costs are called costs variances. Afavorable 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. LO 2

13. LO 2 Budgetary Performance Evaluation WR Western Rider’s standard costs per unit for XL jeans are shown in Exhibit 1.

14. LO 2 Budget Performance Report WR

15. LO 2 Manufacturing Cost Variances

16. Learning Objective 3 Compute and interpret direct materials and direct labor variances.

17. Direct Materials Variances LO 3 WR During June, Western Rider reported an unfavorable total direct materials cost variance of $2,650 for the production of 5,000 XL style jeans, as shown in Exhibit 2and reproduced below. (continued)

18. LO 3 Direct Materials Variance Relationships WR Standard cost: Actual cost: Standard quantity x Standard price 7,500 x $5.00 =$37,500 Actual quantity x Actual price 7,300 x $5.50 =$40,150 Actual quantity x Standard price 7,300 x $5.00 =$36,500 Direct materials price variance Direct materials quantity variance $3,650 U – $1,000 F Total direct materials cost variance $40,150 – $37,500 =$2,650 U

19. Direct Material Variances • Practice exercise 22-1A • Practice exercise 22-2B

20. Direct Labor Variances LO 3 WR During June, Western Rider reported an unfavorable total direct labor cost variance of $2,500 for the production of 5,000 XL style jeans, as shown in Exhibit 2 and reproduced below.

21. LO 3 Direct Labor Variance Relationships WR Actual cost: Standard cost: Actual hours x Actual rate 3,850 x $10 =$38,500 Actual hours x Standard rate 3,850 x $9 =$34,650 Standard hours x Standard rate 4,000 x $9 =$36,000 Direct labor rate variance Direct labor time variance $3,850 U –$1,350 F Total direct labor cost variance $38,500 – $36,000 = $2,500 U

22. Direct Labor Variances • Practice exercise 22-2A • Practice exercise 22-2B

23. Learning Objective 4 Compute and interpret factory overhead controllable volume variances.

24. Factory Overhead Variance

25. Factory Overhead Variances Factory overhead costs are more difficult to analyze than direct labor and materials costs. This is because factory overhead costs have fixed and variable cost elements. Total variance consists of: Controllable variance Volume variance LO 4

26. Factory Overhead Flexible Budget LO 4 WR

27. Budgeted Factory Overhead at Normal Capacity Normal Productive Capacity = Factory Overhead Rate $30,000 5,000 direct labor hours = Factory Overhead Rate LO 4 Budgeted Factory Overhead Rate WR Factory Overhead Rate = $6.00 per direct labor hour

28. $18,000 5,000 direct labor hours Variable Factory Overhead Rate = LO 4 Variable Factory Overhead Rate WR Budgeted Variable Overhead at Normal Capacity Normal Productive Capacity Variable Factory Overhead Rate = Variable Factory Overhead Rate =$3.60 per direct labor hour

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

30. Variable Factory Overhead Controllable Variance Variable Factory Overhead Rate Standard Hours for Actual Units Produced x LO 4 Variable Factory Overhead Controllable Variance Budgeted Variable Factory Overhead Actual Variable Factory Overhead – =

31. $14,400 Variable Factory Overhead Controllable Variance = $10,400 – $14,400 Variable Factory Overhead Controllable Variance – $4,000 Favorable Variance = LO 4 Variable Factory Overhead Controllable Variance WR Variable Factory Overhead Controllable Variance Budgeted Variable Factory Overhead Actual Variable Factory Overhead – = 4,000 direct labor hours x $3.60

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

33. LO 4 Fixed Factory Overhead Volume Variance WR

34. An unfavorable volume variance may be due to factors such as: Failure to maintain an even flow of work Machine breakdowns Work stoppages caused by lack of materials or skilled labor Lack of enough sales orders to keep the factory operating at normal capacity LO 4 Fixed Factory Overhead Volume Variance

35. Factory Overhead Variance • Controllable • Practice exercise 22-3A • Practice exercise 22-3B • Volume • Practice exercise 22-4A • Practice exercise 22-4B

36. LO 4 Reporting Factory Overhead Variances WR

37. 4,000 hours x $6.00 per hour $10,400 + $12,000 LO 4 Factory Overhead Account WR Factory Overhead Actual factory overhead 22,400 Applied factory overhead 24,000

38. Overapplied factory overhead LO 4 Factory Overhead Account WR Factory Overhead Actual factory overhead 22,400 Applied factory overhead 24,000 Balance, June 30 1,600

39. Budgeted Factory Overhead for Amount Produced Variable factory OH $14,400 Fixed factory OH 12,000 Total $26,400 LO 4 Factory Overhead Account WR Actual factory overhead $22,400 Applied factory overhead $24,000 Actual Factory Overhead $22,400 Applied Factory Overhead $24,000 $2,400 U – $4,000 F Controllable Variance Volume Variance – $1,600 F Total Factory Overhead Cost Variance

40. Performance Evaluation Using Variances from Standard Costs Cost Behavior and Cost-Volume-Profit Analysis Performance Evaluation Using Variances from Standard Costs Performance Evaluation Using Variances from Standard Costs The End