Standard costs and operating performance measures

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  • Chapter 11: Standard Costs and Operating Performance Measures This chapter extends our study of management control by explaining how standard costs are used by managers to control costs. It demonstrates how to compute direct materials, direct labor, and variable overhead variances. The chapter also defines some nonfinancial performance measures that are frequently used by companies.
  • A standard is a benchmark or “norm” for measuring performance. In managerial accounting, two types of standards are commonly used by manufacturing, service, food and not-for-profit organizations: Quantity standards specify how much of an input should be used to make a product or provide a service. For example: Auto service centers like Firestone and Sears set labor time standards for the completion of work tasks. Fast-food outlets such as McDonald’s have exacting standards for the quantity of meat going into a sandwich. Price standards specify how much should be paid for each unit of the input. For example: Hospitals have standard costs for food, laundry, and other items. Home construction companies have standard labor costs that they apply to sub-contractors such as framers, roofers, and electricians. Manufacturing companies often have highly developed standard costing systems that establish quantity and price standards for each separate product’s material, labor and overhead inputs. These standards are listed on a standard cost card.
  • Management by exception is a system of management in which standards are set for various operating activities, with actual results compared to these standards. Any deviations that are deemed significant are brought to the attention of management as “exceptions.” This chapter applies the management by exception principle to quantity and price standards with an emphasis on manufacturing applications.
  • The variance analysis cycle is a continuous process used to identify and solve problems: The cycle begins with the preparation of standard cost performance reports in the accounting department. These reports highlight variances that are differences between actual results and what should have occurred according to standards. The Variances raise questions such as: Why did this variance occur? Why is this variance larger than it was last period? The significant variances are investigated to discover their root causes. Corrective actions are taken. Next period’s operations are carried out and the process is repeated.
  • Setting price and quantity standards requires the combined expertise of everyone who has responsibility for purchasing and using inputs. In a manufacturing setting, this might include accountants, engineers, purchasing managers, production supervisors, line managers, and production workers. Standards should be designed to encourage efficient future operations, not just a repetition of past inefficient operations.
  • Standards tend to fall into one of two categories: Ideal standards can only be attained under the best of circumstances. They allow for no work interruptions and they require employees to work at 100% peak efficiency all of the time. Practical standards are tight, but attainable. They allow for normal machine downtime and employee rest periods and can be attained through reasonable, highly efficient efforts of the average worker. Practical standards can also be used for forecasting cash flows and in planning inventory.
  • Learning objective number 1 is to e xplain how direct materials standards and direct labor standards are set.
  • The standard price per unit for direct materials should reflect the final, delivered cost of the materials, net of any discounts taken. The standard quantity per unit for direct materials should reflect the amount of material required for each unit of finished product, as well as an allowance for unavoidable waste, spoilage, and other normal inefficiencies. A bill of materials is a list that shows the quantity of each type of material in a unit of finished product.
  • Six Sigma advocates argue that waste and spoilage should not be tolerated. If allowances for waste and spoilage are built into the standard quantity, the level of those allowances should be reduced over time.
  • The standard rate per hour for direct labor includes not only wages earned but also fringe benefits and other labor costs. Many companies prepare a single rate for all employees within a department that reflects the “mix” of wage rates earned.   The standard hours per unit reflects the labor hours required to complete one unit of product. Standards can be determined by using available references that estimate the time needed to perform a given task, or by relying on time and motion studies.
  • The price standard for variable manufacturing overhead comes from the variable portion of the predetermined overhead rate. The quantity standard for variable manufacturing overhead is expressed in either direct labor hours or machine hours depending on which is used as the allocation base in the predetermined overhead rate.
  • The standard cost card is a detailed listing of the standard amounts of direct materials, direct labor, and variable overhead inputs that should go into a unit of product, multiplied by the standard price or rate that has been set for each input.
  • Price and quantity standards are determined separately for two reasons: Different managers are usually responsible for buying and for using inputs. For example: 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 points in time. For example: Raw material purchases may be held in inventory for a period of time before being used in production.
  • Differences between standard prices and actual prices and standard quantities and actual quantities are called variances. The act of computing and interpreting variances is called variance analysis.
  • Price and quantity variances can be computed for all three variable cost elements – direct materials, direct labor, and variable manufacturing overhead – even though the variances have different names as shown.
  • Although price and quantity variances are known by different names, they are computed exactly the same way (as shown on this slide) for direct materials, direct labor, and variable manufacturing overhead.
  • The actual quantity represents the amount of direct materials, direct labor, and variable manufacturing overhead actually used.
  • The standard quantity represents the standard quantity allowed for the actual output of the period.
  • The actual price represents the actual amount paid for the input used.
  • The standard price represents the amount that should have been paid for the input used.
  • In equation form, price and quantity variances are calculated as shown.
  • Learning objective number 2 is to c ompute the direct materials price and quantity variances and explain their significance.
  • Here’s an example that will give us an opportunity to compute material price and quantity variances.
  • The materials price variance, defined as the difference between what is paid for a quantity of materials and what should have been paid according to the standard, is $21 favorable. The price variance is labeled favorable because the actual price was less than the standard price by $0.10 per kilogram. The materials quantity variance, defined as the difference between the quantity of materials used in production and the quantity that should have been used according to the standard, is $50 unfavorable. The quantity variance is labeled unfavorable because the actual quantity exceeds the standard quantity allowed by 10 kilograms
  • The actual price of $4.90 per kilogram is computed by dividing the actual cost of the material by the actual number of kilograms purchased.
  • The standard quantity of 200 kilograms is computed by multiplying the standard quantity per parka times the number of parkas made.
  • The equations that we have been using thus far can be factored as shown and used to compute price and quantity variances.
  • Most companies compute the materials price variance when materials are purchased. They calculate the materials quantity variance after materials are used in production.
  • The materials price variance is computed using the entire amount of material purchased during the period. The materials quantity variance is computed using only the portion of materials that was used in production during the period.
  • The purchasing manager and production manager are usually held responsible for the materials price variance and materials quantity variance, respectively. The standard price is used to compute the quantity variance so that the production manager is not held responsible for the performance of the purchasing manager.
  • The materials variances are not always entirely controllable by one person or department. For example, the production manager may schedule production in such a way that it requires express delivery of raw materials resulting in an unfavorable materials price variance. The purchasing manager may purchase lower quality raw materials resulting in an unfavorable materials quantity variance for the production manager.
  • Learning objective number 3 is to c ompute the direct labor rate and efficiency variances and explain their significance.
  • Now let’s turn our attention back to Glacier Peak Outfitters to illustrate the computation of labor rate and efficiency variances.
  • The labor rate variance, defined as the difference between the actual average hourly wage paid and the standard hourly wage, is $1,250 unfavorable. The rate variance is labeled unfavorable because the actual average wage rate was more than the standard wage rate by $0.50 per hour. The labor efficiency variance, defined as the difference between the actual quantity of labor hours and the quantity allowed according to the standard, is $1,000 unfavorable. The efficiency variance is labeled unfavorable because the actual quantity of hours exceeds the standard quantity allowed by 100 hours.
  • The actual price (or rate) of $10.50 per hour is computed by dividing the actual total cost for labor by the actual number of hours worked.
  • The standard quantity of 2,400 hours is computed by multiplying the standard hours for one parka times the number of parkas made.
  • Factored equations can also be used to compute the rate and efficiency variances.
  • Labor variances are partially controllable by employees within the Production Department. For example, production managers/supervisors can influence: The deployment of highly skilled workers and less skilled workers on tasks consistent with their skill levels. The level of employee motivation within the department. The quality of production supervision. The quality of the training provided to the employees.
  • However, labor variances are not entirely controllable by one person or department. For example: The Maintenance Department may do a poor job of maintaining production equipment. This may increase the processing time required per unit, thereby causing an unfavorable labor efficiency variance. The purchasing manager may purchase lower quality raw materials resulting in an unfavorable labor efficiency variance for the production manager.
  • Learning objective number 4 is to c ompute the variable manufacturing overhead rate and efficiency variances.
  • Now that we have studied material and labor variances, let’s take a look a variable manufacturing overhead variances. We will return to Glacier Peak Outfitters to illustrate the computation of variable manufacturing overhead rate and efficiency variances.
  • The variable overhead rate variance, defined as the difference between the actual variable overhead costs incurred during the period and the standard cost that should have been incurred based on the actual activity of the period, is $500 unfavorable. The rate variance is labeled unfavorable because the actual variable overhead rate was more than the standard variable overhead rate by $0.20 per hour. The variable overhead efficiency variance, defined as the difference between the actual activity of a period and the standard activity allowed, multiplied by the variable part of the predetermined overhead rate, is $400 unfavorable. The efficiency variance is labeled unfavorable because the actual quantity of the activity (hours) exceeds the standard quantity of the activity allowed by 100 hours.
  • The actual price of $4.20 per hour is computed by dividing the actual total cost for variable manufacturing overhead by the actual number of hours worked.
  • The standard quantity of 2,400 hours is computed by multiplying the standard hours for one parka times the number of parkas made.
  • Factored equations can be used to compute the rate and efficiency variances.
  • All variances are not worth investigating. Methods for highlighting a subset of variances as exceptions include: Looking at the size of the variance. Looking at the size of the variance relative to the amount of spending.
  • Plotting variance analysis data on a statistical control chart is helpful in variance investigation decisions. Variances are investigated if: They are unusual relative to the normal level of random fluctuation. An unusual pattern emerges in the data.
  • Research has shown that a substantial portion of companies in the United Kingdom, Canada, Japan, and the United States use standard cost systems. This is because standard cost systems offer many advantages including: Standard costs are a key element of the management by exception approach which helps managers focus their attention on the most important issues. Standards that are viewed as reasonable by employees can serve as benchmarks that promote economy and efficiency. Standard costs can greatly simplify bookkeeping. Standard costs fit naturally into a responsibility accounting system.
  • The use of standard costs can also present a number of problems. For example: Standard cost variance reports are usually prepared on a monthly basis and are often released days or weeks after the end of the month; hence, the information can be outdated. If variances are misused as a club to negatively reinforce employees, morale may suffer and employees may make dysfunctional decisions. Labor variances make two important assumptions. First, they assume that the production process is labor-paced; if labor works faster, output will go up. Second, the computations assume that labor is a variable cost. These assumptions are often invalid in today’s automated manufacturing environment where employees are essentially a fixed cost. In some cases, a “favorable” variance can be as bad or worse than an unfavorable variance. Excessive emphasis on meeting the standards may overshadow other important objectives such as maintaining and improving quality, on-time delivery, and customer satisfaction. Just meeting standards may not be sufficient; continual improvement using techniques such as Six Sigma may be necessary to survive in a competitive environment.
  • Learning objective number 6 is to compute and interpret the fixed overhead budget and volume variances.
  • Here we see the general model for computing fixed overhead variances. The budget variance is the actual fixed manufacturing overhead cost minus the budgeted fixed manufacturing overhead.
  • The volume variance is budgeted fixed overhead minus the fixed overhead applied to work in process.
  • The volume variance can also be computed by multiplying the fixed portion of the predetermined overhead rate times the difference between denominator hours and standard hours. The equation on the prior slide and this equation result in identical answers. Both variance computations will be demonstrated in the forthcoming example. 
  • ColaCo’s production and machine-hour data is shown on your screen.
  • ColaCo’s overhead production costs are presented here.
  • Part I. The predetermined overhead rate is equal to the estimated total manufacturing overhead cost divided by the estimated total amount of the allocation base. Part II. ColaCo’s predetermined overhead rate is $4.00 per machine hour.
  • Part I. The predetermined overhead rate can be broken down into a variable component and a fixed component. The variable component is $1.00 per machine-hour. Part II. The fixed component, which will be used to compute the volume variance is $3.00 per hour.
  • Part I. The total overhead applied to work in process is computed by multiplying the predetermined overhead rate times the standard hours allowed for the actual output. Part II. The total overhead applied to work in process is $336,000. In the job-order costing chapter, we used the actual level of activity to apply overhead costs to work in process. The different approach arises because we are using a standard cost system in this chapter and the job-order costing chapter uses a normal costing system.
  • The budget variance of $10,000 is the difference between the actual fixed overhead ($280,000) and the budgeted fixed overhead ($270,000). The variance is labeled as Unfavorable because the company actually incurred more cost than the budget projected.
  • Part I. The volume variance is budgeted fixed overhead minus the fixed overhead applied to work in process. The fixed overhead applied to work in process is equal to the fixed component of the predetermined overhead rate times the standard hours allowed for the actual output. Part II. The fixed overhead applied to work in process ($252,000) is computed by multiplying the fixed component of the predetermined overhead rate ($3.00) by the standard machine-hours allowed for the actual output (84,000 hours). The volume variance is $18,000 unfavorable.
  • Part I. The volume variance can also be computed by multiplying the fixed portion of the predetermined overhead rate times the difference between denominator hours and standard hours. Part II. The volume variance is $18,000 unfavorable. Because the standard hours allowed is less than the denominator volume hours, it presumably signals inefficient usage of facilities. Therefore, the variance is labeled as unfavorable.  
  • This slide offers a pictorial view of the computation of the fixed overhead budget and volume variances.  
  • Often it’s helpful to look at the fixed overhead relationships in graphical form. We will use the ColaCo data from the previous example for our graphical approach.
  • The vertical axis is used to graph fixed overhead cost. The first cost that ColaCo would plot on this axis is $270,000 of budgeted fixed overhead. The horizontal axis is used to graph the volume of activity. The first activity level that ColaCo would plot is its denominator activity level of 90,000 machine hours. The linear manner in which fixed overhead is applied to products is depicted by drawing a straight line from the origin to the intersection of the budgeted fixed overhead ($270,000) and the denominator activity (90,000 hours). The slope of this line indicates that fixed overhead is applied at a rate of $3.00 per machine hour.
  • Next, plot the actual amount of fixed overhead costs on the vertical axis. The broken horizontal line above the budgeted fixed overhead represents the $280,000 of actual fixed manufacturing overhead. The vertical distance between the budgeted fixed overhead line and the actual fixed overhead line represents the fixed overhead budget variance of $10,000. Since the actual fixed overhead is greater than the budgeted fixed overhead, the fixed overhead budget variance is unfavorable.
  • Finally, identify the standard hours allowed for the actual level of output (84,000 hours) on the horizontal axis. Draw a vertical line from this activity level until it intersects the sloped line that depicts the fixed overhead applied to products. From this point, draw a horizontal line representing the applied fixed overhead ($252,000). The vertical distance between the budgeted fixed overhead line and the applied fixed overhead line represents the fixed overhead volume variance of $18,000. Since the budgeted fixed overhead is greater than the applied fixed overhead, the volume variance is unfavorable.
  • In a standard cost system, the sum of the overhead variances equals the under-or overapplied overhead cost for the period. Unfavorable variances are equivalent to underapplied overhead. Favorable variances are equivalent to overapplied overhead.
  • This slide shows how ColaCo’s underapplied or overapplied is computed.   The manufacturing overhead is $44,000 underapplied.
  • ColaCo’s variable overhead rate variance ($12,000 U) is computed as shown on this slide.
  • ColaCo’s variable overhead efficiency variance ($4,000 U) is computed as shown on this slide.
  • The sum of the variable and fixed overhead variances is $44,000 U. Notice, the sum of the variances equals the amount of ColaCo’s underapplied overhead.
  • Standard costs and operating performance measures

    1. 1. Standard Costs and Operating Performance Measures
    2. 2. Standard Costs Standards are benchmarks or “norms” formeasuring performance. In managerial accounting, two types of standards are commonly used. Quantity standards Price standards specify how much of an specify how much input should be used to should be paid for make a product or each unit of the provide a service. input.Examples: Firestone, Sears, McDonald’s, hospitals, construction and manufacturing companies.McGraw-Hill/Irwin Slide 2
    3. 3. Standard Costs Deviations from standards deemed significant are brought to the attention of management, a practice known as management by exception. Standard Amount Direct Material Direct Manufacturing Labor Overhead Type of Product CostMcGraw-Hill/Irwin Slide 3
    4. 4. Variance Analysis Cycle Take Identify Receive corrective questions explanations actions Conduct next Analyze period’s variances operations Prepare standard Begin cost performance reportMcGraw-Hill/Irwin Slide 4
    5. 5. Setting Standard Costs Accountants, engineers, purchasing agents, and production managers combine efforts to set standards that encourage efficient future operations.McGraw-Hill/Irwin Slide 5
    6. 6. Setting Standard Costs Should we use I recommend using practical ideal standards that standards that are currently require employees to attainable with reasonable work at 100 percent and efficient effort. peak efficiency? Engineer Managerial AccountantMcGraw-Hill/Irwin Slide 6
    7. 7. Learning Objective 1 Explain how direct materials standards and direct labor standards are set.McGraw-Hill/Irwin Slide 7
    8. 8. Setting Direct Material Standards Price Quantity Standards Standards Final, delivered Summarized in cost of materials, a Bill of Materials. net of discounts.McGraw-Hill/Irwin Slide 8
    9. 9. 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.McGraw-Hill/Irwin Slide 9
    10. 10. Setting Direct Labor Standards Rate Time Standards Standards Often a single Use time and rate is used that reflects motion studies for the mix of wages earned. each labor operation.McGraw-Hill/Irwin Slide 10
    11. 11. Setting Variable Manufacturing Overhead Standards Rate Quantity Standards Standards The rate is the The quantity is variable portion of the the activity in the predetermined overhead allocation base for rate. predetermined overhead.McGraw-Hill/Irwin Slide 11
    12. 12. Standard Cost Card – Variable Production Cost A standard cost card for one unit of product might look like this: A B AxB Standard Standard Standard Quantity Price Cost Inputs or Hours or Rate per Unit Direct materials 3.0 lbs. $ 4.00 per lb. $ 12.00 Direct labor 2.5 hours 14.00 per hour 35.00 Variable mfg. overhead 2.5 hours 3.00 per hour 7.50 Total standard unit cost $ 54.50McGraw-Hill/Irwin Slide 12
    13. 13. 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.McGraw-Hill/Irwin Slide 13
    14. 14. A General Model for Variance Analysis Variance Analysis Price Variance Quantity Variance Difference between Difference between actual price and actual quantity and standard price standard quantityMcGraw-Hill/Irwin Slide 14
    15. 15. A General Model for Variance Analysis Variance Analysis Price Variance Quantity Variance Materials price variance Materials quantity variance Labor rate variance Labor efficiency variance VOH rate variance VOH efficiency varianceMcGraw-Hill/Irwin Slide 15
    16. 16. A General Model for Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity VarianceMcGraw-Hill/Irwin Slide 16
    17. 17. A General Model for Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance Actual quantity is the amount of direct materials, direct labor, and variable manufacturing overhead actually used.McGraw-Hill/Irwin Slide 17
    18. 18. A General Model for Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance Standard quantity is the standard quantity allowed for the actual output of the period.McGraw-Hill/Irwin Slide 18
    19. 19. A General Model for Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance Actual price is the amount actually paid for the input used.McGraw-Hill/Irwin Slide 19
    20. 20. A General Model for Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance Standard price is the amount that should have been paid for the input used.McGraw-Hill/Irwin Slide 20
    21. 21. A General Model for Variance Analysis Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance (AQ × AP) – (AQ × SP) (AQ × SP) – (SQ × SP) AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard QuantityMcGraw-Hill/Irwin Slide 21
    22. 22. Learning Objective 2 Compute the direct materials price and quantity variances and explain their significance.McGraw-Hill/Irwin Slide 22
    23. 23. Material Variances – An Example Glacier Peak Outfitters has the following direct material standard for the fiberfill in its mountain parka. 0.1 kg. of fiberfill per parka at $5.00 per kg. Last month 210 kgs. of fiberfill were purchased and used to make 2,000 parkas. The material cost a total of $1,029.McGraw-Hill/Irwin Slide 23
    24. 24. Material Variances Summary Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 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 Quantity variance $21 favorable $50 unfavorableMcGraw-Hill/Irwin Slide 24
    25. 25. Material Variances Summary Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 210 kgs. 210 kgs. 200 kgs. × × $1,029 ÷ 210 kgs × $4.90 per kg. $5.00 per kg. = $4.90 per kg $5.00 per kg. = $1,029 = $1,050 = $1,000 Price variance Quantity variance $21 favorable $50 unfavorableMcGraw-Hill/Irwin Slide 25
    26. 26. Material Variances Summary Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 210 kgs. 210 kgs. 200 kgs. × 0.1 kg per parka× 2,000 parkas × × $4.90 per kg. $5.00 per kg. = 200 kgs $5.00 per kg. = $1,029 = $1,050 = $1,000 Price variance Quantity variance $21 favorable $50 unfavorableMcGraw-Hill/Irwin Slide 26
    27. 27. 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 UMcGraw-Hill/Irwin Slide 27
    28. 28. Isolation of Material Variances I need the price variance I’ll start computing sooner so that I can better the price variance identify purchasing problems. when material is You accountants just don’t purchased rather understand the problems that than when it’s used. purchasing managers have.McGraw-Hill/Irwin Slide 28
    29. 29. Material Variances The price variance is Hanson purchased and computed on the entire used 1,700 pounds. quantity purchased. How are the variances computed if the amount The quantity variance purchased differs from is computed only on the amount used? the quantity used.McGraw-Hill/Irwin Slide 29
    30. 30. Responsibility for Material VariancesMaterials Quantity Variance Materials Price 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.McGraw-Hill/Irwin Slide 30
    31. 31. Responsibility for Material Variances Your poor scheduling I am not responsible for sometimes requires me to this unfavorable material rush order material at a quantity variance. higher price, causing unfavorable price variances. You purchased cheap material, so my people had to use more of it.McGraw-Hill/Irwin Slide 31
    32. 32. Learning Objective 3 Compute the direct labor rate and efficiency variances and explain their significance.McGraw-Hill/Irwin Slide 32
    33. 33. Labor Variances – An Example Glacier Peak Outfitters has the following direct labor 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 labor cost of $26,250 to make 2,000 parkas.McGraw-Hill/Irwin Slide 33
    34. 34. Labor Variances Summary Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 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 Efficiency variance $1,250 unfavorable $1,000 unfavorableMcGraw-Hill/Irwin Slide 34
    35. 35. Labor Variances Summary Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours 2,500 hours 2,400 hours × × $26,250 ÷ 2,500 hours ×$10.50 per hour $10.00 per hour. = $10.50 per hour $10.00 per hour = $26,250 = $25,000 = $24,000 Rate variance Efficiency variance $1,250 unfavorable $1,000 unfavorableMcGraw-Hill/Irwin Slide 35
    36. 36. Labor Variances Summary Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours 2,500 hours 2,400 hours × × 1.2 hours per parka × 2,000 ×$10.50 per hour parkas = 2,400hour. $10.00 per hours $10.00 per hour = $26,250 = $25,000 = $24,000 Rate variance Efficiency variance $1,250 unfavorable $1,000 unfavorableMcGraw-Hill/Irwin Slide 36
    37. 37. Labor Variances: Using the Factored Equations Labor 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 unfavorable Labor efficiency variance LEV = SR (AH - SH) = $10.00 per hour (2,500 hours – 2,400 hours) = $10.00 per hour (100 hours) = $1,000 unfavorableMcGraw-Hill/Irwin Slide 37
    38. 38. Responsibility for Labor Variances Production managers are Mix of skill levels usually held accountable assigned to work tasks. for labor variances because they can Level of employee influence the: motivation. Quality of production supervision. Quality of training provided to employees. Production ManagerMcGraw-Hill/Irwin Slide 38
    39. 39. Responsibility for Labor Variances I think it took more time to process the I am not responsible for materials because the the unfavorable labor Maintenance efficiency variance! Department has poorly maintained your You purchased cheap equipment. material, so it took more time to process it.McGraw-Hill/Irwin Slide 39
    40. 40. Learning Objective 4 Compute the variable manufacturing overhead rate and efficiency variances.McGraw-Hill/Irwin Slide 40
    41. 41. Variable Manufacturing Overhead Variances – An Example Glacier Peak Outfitters has the following direct variable manufacturing overhead labor 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.McGraw-Hill/Irwin Slide 41
    42. 42. Variable Manufacturing Overhead Variances Summary 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 Rate variance Efficiency variance $500 unfavorable $400 unfavorableMcGraw-Hill/Irwin Slide 42
    43. 43. Variable Manufacturing Overhead Variances Summary Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours 2,500 hours 2,400 hours × × $10,500 ÷ 2,500 hours × $4.20 per hour $4.00 per per hour = $4.20 hour $4.00 per hour = $10,500 = $10,000 = $9,600 Rate variance Efficiency variance $500 unfavorable $400 unfavorableMcGraw-Hill/Irwin Slide 43
    44. 44. Variable Manufacturing Overhead Variances Summary Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours 2,500 hours 2,400 hours × 1.2 hours per parka × 2,000 × × $4.20 per hour parkas = 2,400hour $4.00 per hours $4.00 per hour = $10,500 = $10,000 = $9,600 Rate variance Efficiency variance $500 unfavorable $400 unfavorableMcGraw-Hill/Irwin Slide 44
    45. 45. Variable Manufacturing Overhead Variances: Using Factored Equations Variable manufacturing overhead rate variance VMRV = AH (AR - SR) = 2,500 hours ($4.20 per hour – $4.00 per hour) = 2,500 hours ($0.20 per hour) = $500 unfavorable 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 unfavorableMcGraw-Hill/Irwin Slide 45
    46. 46. Variance Analysis and Management by Exception Larger variances, in How do I know dollar amount or as which variances to a percentage of the investigate? standard, are investigated first.McGraw-Hill/Irwin Slide 46
    47. 47. A Statistical Control Chart Warning signals for investigationFavorable Limit • • • • •Desired Value • •Unfavorable Limit • • 1 2 3 4 5 6 7 8 9 Variance MeasurementsMcGraw-Hill/Irwin Slide 47
    48. 48. Advantages of Standard Costs Management by Promotes economy exception and efficiency Advantages Enhances Simplified responsibility bookkeeping accountingMcGraw-Hill/Irwin Slide 48
    49. 49. Potential Problems with Standard CostsEmphasizing standards Favorable may exclude other variances may important objectives. be misinterpreted. Potential Problems Standard cost Emphasis on reports may negative may not be timely. impact morale. Invalid assumptions Continuous about the relationship improvement may between labor be more important cost and output. than meeting standards. McGraw-Hill/Irwin Slide 49
    50. 50. Learning Objective 5 Compute and interpret the fixed overhead budget and volume variances.McGraw-Hill/Irwin Slide 50
    51. 51. Fixed Overhead Budget Variance Actual Budgeted Fixed Fixed Fixed Overhead Overhead Overhead Applied Budget variance Actual Budgeted Budget = fixed – fixed variance overhead overheadMcGraw-Hill/Irwin Slide 51
    52. 52. Fixed Overhead Volume Variance Actual Budgeted Fixed Fixed Fixed Overhead Overhead Overhead Applied Volume variance Fixed Budgeted Volume overhead = fixed – variance applied to overhead work in processMcGraw-Hill/Irwin Slide 52
    53. 53. Fixed Overhead Volume Variance Actual Budgeted Fixed Fixed Fixed Overhead Overhead Overhead Applied DH × FR SH × FR Volume variance Volume variance = FPOHR × (DH – SH)FPOHR = Fixed portion of the predetermined overhead rate DH = Denominator hours SH = Standard hours allowed for actual outputMcGraw-Hill/Irwin Slide 53
    54. 54. Computing Fixed Overhead Variances ColaCo Production and Machine-Hour DataBudgeted production 30,000 unitsStandard machine-hours per unit 3 hoursBudgeted machine-hours 90,000 hoursActual production 28,000 unitsStandard machine-hours allowed for the actual production 84,000 hoursActual machine-hours 88,000 hoursMcGraw-Hill/Irwin Slide 54
    55. 55. Computing Fixed Overhead Variances ColaCo Cost Data Budgeted variable manufacturing overhead $ 90,000 Budgeted fixed manufacturing overhead 270,000 Total budgeted manufacturing overhead $ 360,000 Actual variable manufacturing overhead $ 100,000 Actual fixed manufacturing overhead 280,000 Total actual manufacturing overhead $ 380,000McGraw-Hill/Irwin Slide 55
    56. 56. Predetermined Overhead RatesPredetermined Estimated total manufacturing overhead cost =overhead rate Estimated total amount of the allocation basePredetermined $360,000 =overhead rate 90,000 Machine-hoursPredetermined = $4.00 per machine-houroverhead rateMcGraw-Hill/Irwin Slide 56
    57. 57. Predetermined Overhead Rates Variable component of the $90,000 = predetermined overhead rate 90,000 Machine-hours Variable component of the = $1.00 per machine-hour predetermined overhead rate Fixed component of the $270,000 = predetermined overhead rate 90,000 Machine-hours Fixed component of the = $3.00 per machine-hour predetermined overhead rateMcGraw-Hill/Irwin Slide 57
    58. 58. Applying Manufacturing Overhead Overhead Predetermined Standard hours allowed = × applied overhead rate for the actual output Overhead $4.00 per = × 84,000 machine-hours applied machine-hour Overhead = $336,000 appliedMcGraw-Hill/Irwin Slide 58
    59. 59. Computing the Budget Variance Actual Budgeted Budget = fixed – fixed variance overhead overhead Budget = $280,000 – $270,000 variance Budget = $10,000 Unfavorable varianceMcGraw-Hill/Irwin Slide 59
    60. 60. Computing the Volume Variance Fixed BudgetedVolume overhead = fixed –variance applied to overhead work in processVolumevariance = $270,000 – ( $3.00 per machine-hour × $84,000 machine-hours )Volume = $18,000 UnfavorablevarianceMcGraw-Hill/Irwin Slide 60
    61. 61. Computing the Volume Variance Volume variance = FPOHR × (DH – SH)FPOHR = Fixed portion of the predetermined overhead rate DH = Denominator hours SH = Standard hours allowed for actual outputVolumevariance = $3.00 per machine-hour × ( 90,000 mach-hours – 84,000 mach-hours )Volume = 18,000 UnfavorablevarianceMcGraw-Hill/Irwin Slide 61
    62. 62. A Pictorial View of the Variances Actual Budgeted Fixed Overhead Fixed Fixed Applied to Overhead Overhead Work in Process 280,000 270,000 252,000 Budget variance, Volume variance, $10,000 unfavorable $18,000 unfavorable Total variance, $28,000 unfavorableMcGraw-Hill/Irwin Slide 62
    63. 63. 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.McGraw-Hill/Irwin Slide 63
    64. 64. Graphic Analysis of Fixed Overhead Variances Budget$270,000 d at lie pp ur d a rd ho ea da erh tan d ov r s xe 0 pe Fi .0 Denominator $3 hours 0 0 Machine-hours (000) 90McGraw-Hill/Irwin Slide 64
    65. 65. Graphic Analysis of Fixed Overhead Variances Actual$280,000 Budget { Budget Variance 10,000 U$270,000 d at lie pp ur d a rd ho ea da erh tan d ov r s xe 0 pe Fi .0 Denominator $3 hours 0 0 Machine-hours (000) 90McGraw-Hill/Irwin Slide 65
    66. 66. Graphic Analysis of Fixed Overhead Variances Actual$280,000 Budget { Budget Variance 10,000 U$270,000Applied { Volume Variance 18,000 U$252,000 d at lie pp ur d a rd ho ea da erh tan d ov r s xe 0 pe Fi .0 Standard Denominator $3 hours hours 0 0 Machine-hours (000) 84 90McGraw-Hill/Irwin Slide 66
    67. 67. Reconciling Overhead Variances and Underapplied or Overapplied Overhead In a standard cost system: Unfavorable Favorable variances are equivalent variances are equivalent to underapplied overhead. to overapplied overhead. The sum of the overhead variances equals the under- or overapplied overhead cost for the period.McGraw-Hill/Irwin Slide 67
    68. 68. Reconciling Overhead Variances and Underapplied or Overapplied Overhead ColaCo Computation of Underapplied OverheadPredetermined overhead rate (a) $ 4.00 per machine-hourStandard hours allowed for the actual output (b) 84,000 machine hoursManufacturing overhead applied (a) × (b) $ 336,000Actual manufacturing overhead $ 380,000Manufacturing overhead underapplied or overapplied $ 44,000 underappliedMcGraw-Hill/Irwin Slide 68
    69. 69. Computing the Variable Overhead Variances Variable manufacturing overhead rate variance VMRV = (AH × AR) – (AH × SR) = $100,000 – (88,000 hours × $1.00 per hour) = $12,000 unfavorableMcGraw-Hill/Irwin Slide 69
    70. 70. Computing the Variable Overhead Variances Variable manufacturing overhead efficiency variance VMEV = (AH × SR) – (SH × SR) = $88,000 – (84,000 hours × $1.00 per hour) = $4,000 unfavorableMcGraw-Hill/Irwin Slide 70
    71. 71. Computing the Sum of All Variances ColaCo Computing the Sum of All variances Variable overhead rate variance $ 12,000 U Variable overhead efficiency variance 4,000 U Fixed overhead budget variance 10,000 U Fixed overhead volume variance 18,000 U Total of the overhead variances $ 44,000 UMcGraw-Hill/Irwin Slide 71

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