Chapter 21

1. Chapter 21 Flexible Budgets and Standard Costing

2. Conceptual Learning Objectives C1: Define standard costs and explain their computation and uses. =>QUIZ C2: Describe variances and what they reveal about performance. C3: Explain how standard cost information is useful for management by exception.

3. Analytical Learning Objectives A1:Compare fixed and flexible budgets.=>QUIZ A2: Analyze changes in sales from expected amounts.

4. Procedural Learning Objectives P1: Prepare a flexible budget and interpret a flexible budget performance report. => QUIZ P2: Compute materials and labor variances. P3: Compute overhead variances. P4: Prepare journal entries for standard costs and account for price and quantity variances.

5. Budgetary Process Budgetary Control and Reporting Budgetary control:Management’s use of budgets to monitor and control the company’s operations.

6. Budgetary Process Budgetary Control and Reporting Budget reports: a. Contain relevant information that compares actual results to planned objectives. b. Sometimes viewed as progress reports (orreport cards) on management’s performance in achieving planned objectives.

7. Budgetary Process Budgetary control process involves at least four steps: 1. Develop budget from planned objectives. 2. Compare actual results to budgeted amounts; analyze differences. 3. Take corrective and strategic actions. 4. Establish new planned objectives and prepare new budget.

8. Budgetary Control and Reporting P1 • Develop the budgetfrom planned objectives. • Compareactual with budget andanalyze anydifferences. • Reviseobjectivesand preparea newbudget. Management usesbudgets to monitorand controloperations. • Take corrective andstrategic actions.

9. Fixed Budget Performance Report A2

10. Fixed Budget Performance Report A2 If unit sales are higher, should we expect costs to be higher? How much of the higher costs are because of higher unit sales?

11. Purpose of Flexible Budgets A1 Show revenues and expensesthat should have occurred at theactual level of activity. May be prepared for any activity level in the relevant range. Reveal variances due to good cost control or lack of cost control. Improve performance evaluation.

12. Preparing Flexible Budgets To a budget for different activity levels, we must know how costs behave with changes in activity levels. • Total variable costschange in direct proportion to changes in activity. • Total fixedcosts remain unchanged within the relevant range.

13. EXERCISE 21 - 2 (PAGE 893)

14. Preparing Flexible Budgets P1 Variable costs are expressed as a constant amount per unit.

15. Preparing Flexible Budgets P1 Total variable cost = $4.80 per unit × budget level in units

16. Preparing Flexible Budgets P1 Fixed costs are expressed as a total amount thatdoes not changewithin the relevant range of activity.

17. Flexible Budget Performance Report 1. Lists differences between actual performanceandbudgeted performance based on actual salesvolume. 2. Helps management to focus on those areas where corrective actions may help control operations. 3. Used for variance analysis

18. Flexible Budget Performance Report 3. Used for variance analysis: a. Actual and budgeted sales volumes are the same; as such, any variance in total dollar sales must have resulted from a selling price variance. b. Difference between actual quantity of input used and budgeted quantity can be described as a quantity variance. c. Difference between actual price per unit of input and budgeted price per unit of input can be described as a price variance.

19. Flexible Budget Performance Report P1 Favorable sales variance indicates that the average selling price was greater than $10.00.

20. Flexible Budget Performance Report P1 Unfavorable cost variances indicatecosts that are greater than expected.

21. Flexible Budget Performance Report P1 Favorable variances because favorable sales variance overcomes unfavorable cost variances.

22. QUICK STUDY 21 - 1 (PAGE 892) QUICK STUDY 21 -8 (Page 893)

23. Identifying Standard Costs Standard costs are preset costs for delivering a product or service expected under normal conditions.

24. Standard Costs are Standard Costs C 1 Based on carefullypredetermined amounts. Used for planning labor, materialand overhead requirements. The expected levelof performance. Benchmarks formeasuring performance.

25. Setting Standard Costs Actual costs will frequently differ from standard costs. Differences often due to more than one factor: a. Actual quantity used (of direct labor or direct materials) may differ from standard. b. Actual price paid per unit (of direct labor or direct materials) may differ from standard.

26. Setting Standard Costs a. An ideal standard is the quantity of material required if process was 100% efficient without any loss or waste. b. A practical standard is the quantity of material required under normal application of process; allowance for loss included in standard.

27. Practical standards should be set at levels that are currently attainable with reasonable and efficient effort. Should we usepractical standardsor ideal standards? Setting Standard Costs C 1 ProductionManager ManagerialAccountant Engineer

28. PriceStandards QuantityStandards Use competitivebids for the qualityand quantity desired. Use product design specifications. Setting Direct Material Standards C 1

29. Setting Direct Material Standards C 1 The standard material cost for one unit of product is: standard quantity standard price for of material one unit of material required for one unit of product ×

30. RateStandards TimeStandards Use wage surveys andlabor contracts. Use time and motion studies foreach labor operation. Setting Direct Labor Standards C 1

31. Setting Direct Labor Standards C 1 The standard labor cost for one unit of product is: standard number standard wage rate of labor hours for one hour for one unit of product ×

32. RateStandards ActivityStandards The rate is the variable portion of the predetermined overhead rate. The activity is thecost driver used to calculate the predetermined overhead. Setting Variable Overhead Standards C 1

33. Setting Variable Overhead Standards C 1 The standard variable overhead cost for one unit of product is: standard variable standard number overhead rate for of activity units one unit of for one unit of activity product × ×

34. Standard Cost Card Standard cost card includes standard costs of: -direct materials, -direct labor, and -overhead for one unit of product or service.

35. Standard Cost Card A standard cost card might look like this:

36. Standard cost DirectMaterial DirectLabor Cost variance(Variances) A standard cost varianceis the amount by whichan actual cost differs fromthe standard cost. Amount ManufacturingOverhead Type of Product Cost

37. Cost variance(Variances) Variances can be: Favorable: Actual cost is less than standard cost; or Unfavorable: Actual cost is more than standard cost. Short-term favorable variances can lead to long-term unfavorable variances.

38. Variance Analysis Takecorrective actions Identifyquestions Receive explanations Conduct next period’s operations Analyze variances Prepare standard cost performance report Begin

39. Standard Cost Variances Price Variance Quantity Variance The difference betweenthe actual price and thestandard price The difference betweenthe actualquantityandthe standard quantity Computing Variances

40. 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 paidfor the resources acquired. Computing Variances

41. Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance Computing Variances P2 Standard quantity is the quantity thatshould have been usedfor the actual good output.

42. Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price Variance Quantity Variance Materials Variances AQ * (AP - SP) SP * (AQ - SQ) AQ= Actual QuantitySP= Standard PriceAP= Actual PriceSQ= Standard Quantity

43. Materials Variances Material cost variances may be due to price and/or quantity factors: Materials price variance results when company pays different amount per unit than standard price. Purchasing department usually responsible. Materials quantity variance results when company uses a quantity that differs from the standard quantity allowed to produce the actual amount of output. Production department usually responsible. Can also be fault of purchasing department if purchase of inferior materials caused excess usage.

44. Labor Variances ActualHours ActualHoursStandardHours× × ×ActualRate StandardRateStandardRate Rate Variance Efficiency Variance AH * (AR - SR) SR * (AH - SH) AH= Actual Hours SR= Standard RateAR = Actual Rate SH = Standard Hours Materials price variance Materials quantity varianceLabor rate variance Labor efficiency varianceVariable overhead Variable overhead spending variance efficiency variance

45. Labor Variances Labor cost variances may be due to rate (price) and/or efficiency (quantity) factors: Labor rate (price) variance results when wage rate paid to employees differs from standard rate. Personnel administrator usually responsible. Labor efficiency (quantity) variances results when labor hours used differ from the standard quantity of hours allowed to produce the actual amount of output. Production department usually responsible. Labor rate and efficiency variances may be due to use of workers with different skill levels.

46. Poorlytrainedworkers Poorqualitymaterials Poorsupervisionof workers Poorlymaintainedequipment Labor Variances UnfavorableEfficiencyVariance

47. QUICK STUDY 21 – 2 QUICK STUDY 21 – 3 QUICK STUDY 21 – 4 (PAGE 892) EXERCISE 21- 8 EXERCISE 21- 5(PAGE 894 & 895)

48. Overhead Standards and Variances P3 Recall that overhead costs are assigned to products and services using a predetermined overhead rate (POHR): Assigned Overhead = POHR × Standard Activity Estimated total overhead costsEstimated activity POHR =

49. POHR The predetermined overhead rate (POHR) is often based on the relation between: -Standard overhead and standard labor cost, -Standard labor hours, -Standard machine hours, or -Other measure of production.

50. Setting Standard OH Cost Rate • To establish standard overhead cost rate, use same cost structure as that used to construct flexible budget at end of a period. Exhibit 21.12 (page 877) • a. Management selects a level of activity (volume) andpredicts total overhead costs. => 80% OF CAPACITY • b. Many factors affect predicted activity level. -Level of 100% of capacity rarely used. • Factors that cause activity level to be less than full capacity include: -Difficulties in scheduling work, -Equipment under repair or maintenance, and -Insufficient Product demand. • c. Total overhead costs predicted are divided by allocation base to get standard rate.