CHAPTER 8

1. CHAPTER 8 PerformanceEvaluation

2. Learning Objective To describe flexible and static budgets LO1

3. Preparing Flexible Budgets The master budget, sometimes called a static budget, is based solely on the planned volume of activity. Flexible budgets differ from static budgets in that they show expected revenues and costs at a variety of volume levels. Flexible

4. Preparing Flexible Budgets Melrose Manufacturing, a producer of small high-quality trophies, plans to make and sell 18,000 trophies during 2006. Melrose uses a standard cost system as outlined below:

5. Preparing Flexible Budgets With very little effort, the accountant can provide management with a flexible budget for both budgeted and actual levels of activity. The flexible budget is a critical tool in effective performance evaluation.

6. 18,000 × $80 = $1,440,000 Preparing Flexible Budgets From the standard cost information, Melrose prepares the following static and flexible budgets.

7. Learning Objective To classify variances as being favorable or unfavorable LO2

8. Determining Variances for Performance Evaluation The differences between standard and actual amounts are called variances. A variance may befavorable or unfavorable. When actual sales are less than expected, an unfavorable sales variance exists. When actual sales revenue is greater than expected revenue, a company has a favorable sales variance.

9. Learning Objective To compute and interpret sales volume variances LO3

10. Sales Volume Variances The difference between the static budget sales amount and the flexible budget sales amount is a measure of the sales volume variance.

11. Interpreting the Volume Variances In a standard cost system, marketing managers are usually responsible for the volume variance. Because sales volume drives production, production managers have little control over volume variance. In the case of Melrose, the marketing manager exceeded planned sales volume by 1,000 units, resulting in an $80,000 favorable revenue variance ($80 × 1,000). The unfavorable cost variances are somewhat misleading. Melrose incurred higher costs because it manufactured and sold more units than planned.

12. Interpreting the Volume Variances Because actual volume is not known until the end of the period, the selling price must be based on planned volume. At the planned volume of 18,000 units, Melrose’s fixed cost per unit is expected to be as follows: Based on actual volume, fixed cost per unit would be $15.35 ($291,600 ÷ 19,000).

13. Learning Objective To compute and interpret flexible budget variances LO4

14. Flexible Budget Variances For effective performance evaluation, management must compare the actual results achieved to the flexible budget based on the actual volume of activity. Here is a comparison of the standard amount and actual amount per unit for the current period.

15. $78 × 19,000 = $1,482,000 Flexible Budget Variances Now we are comparing actual results achieved with the results that should have been achieved at the activity level.

16. or Calculating Sales Price Variance

17. Learning Objective To explain standard cost systems LO5

18. Standard Cost Systems A standard represents the amount a price, cost, or quantity should be, based on certain anticipated circumstances. Accountants, engineers, purchasing agents, and production managers combine efforts to set standards that encourage efficient future production.

19. Should we useideal standards that represent what costsshould be under thebest circumstances? I recommend usingpractical standardsthat an averageworker performing diligentlywould be able to achieve. Establishing Standards Engineer ManagerialAccountant

20. Need for Standard Costs Standard costs help managers plan and establish benchmarks against which actual performance can be judged.Management by exceptionfocuses on material differences between actual and expected results.

21. Selecting Variances to Investigate • Management by exception tells us to consider: • The materiality of a variance, • How frequently it occurs, • The capacity to control the variance, and • The characteristics of the items behind the variance.

22. Manufacturing Cost Variances We will use the following information provided by Melrose Manufacturing in 2006 to calculate manufacturing variances.

23. Learning Objective To calculate price and usage variances LO6

24. Actual CostColumn Variance DividingColumn Standard CostColumn 117,800×$1.90$223,820 117,800×$2.00$235,600 114,000×$2.00$228,000 Total Variance$4,180 Favorable Materials Price and Usage Variances Actual QuantityUsed × Actual PricePer Pound Actual QuantityUsed × Standard PricePer Pound Standard Quantity × Standard PricePer Pound Materials Price Variance$11,780 Favorable Materials Usage Variance$7,600 Unfavorable

25. ActualPrice StandardPrice – × = 117,800 = $11,780 Favorable – ($1.90 $2.00) UsageVariance ActualQuantity StandardQuantity StandardPrice – × = × = $2.00 – = $7,600 Unfavorable (117,800 114,000) Materials Price and Usage Variances PriceVariance ActualQuantity × =

26. Your poor scheduling sometimes requires me to “rush order” material at a higher price, causing unfavorable price variances. I am not responsible for this unfavorable materialquantity variance. You purchased inferiormaterial, so my peoplehad to use more of it. Production Manager Responsibility for Materials Variances Purchasing Manager

27. Calculating Labor Variances Melrose has provided the following information about labor cost and usage during the period.

28. Actual CostColumn Variance DividingColumn Standard CostColumn 28,500×$11.50$327,750 28,500×$12.00$342,000 26,600×$12.00$319,200 Total Variance$8,550 Unfavorable Labor Price and Usage Variances Actual HoursUsed × Actual PricePer Hour Actual HoursUsed × Standard PricePer Hour Standard Hours × Standard PricePer Hour Labor Price Variance$14,250 Favorable Labor Usage Variance$22,800 Unfavorable

29. ActualPrice StandardPrice – ($11.50 $12.00) – × = 28,500 = $14,250 Favorable UsageVariance ActualHours StandardHours StandardPrice – × = (28,500 26,600) – × = $12.00 = $22,800 Unfavorable Labor Price and Usage Variances PriceVariance ActualHours = ×

30. Responsibility for Labor Variances Production managers areusually held accountablefor labor variancesbecause they caninfluence the: Mix of skill levelsassigned to work tasks. Level of employee motivation. Quality of production supervision. Quality of training provided to employees. Production Manager

31. I am not responsible for the unfavorable laborefficiency variance! You purchased cheapmaterial, so it took moretime to process. Responsibility for Labor Variances I think it took more time to process the materials because the Maintenance Department has poorly maintained your equipment. Production Manager Purchasing Manager

32. ActualCost StandardCost – × = 19,000 – ($5.75 $5.60) = $2,850 Unfavorable Variable Overhead Variances For Melrose’s Flexible Budget VariableOverheadVariance ActualUnits = ×

33. Fixed Overhead Variances Variable costs can have both price and usage variances. Fixed overhead costs can have a price variance. The difference between the actual fixed overhead cost and the budgeted fixed overhead cost is called the spending variance. At Melrose, the spending variance was: ($210,000 actual - $201,600 budgeted) = $8,400 Unfavorable

34. Fixed Overhead Variances Overhead Volume Variance ($201,600 budgeted – $212,800 applied) = $11,200 Favorable

35. ActualFixedCost BudgetedFixedCost AppliedFixedCost $210,000 $201,600 $212,800 Volume Variance$11,200 Favorable Spending Variance$8,400 Unfavorable Fixed Overhead Variances

36. General, Selling & Administrative Cost Variances Variable general, selling, and administrative (GS&A) costs can have price and usage variances. Fixed GS&A costs are also subject to variance analysis. We know that the flexible budget for 19,000 units sold shows GS&A expenses of $90,000. The actual GS&A expenses incurred during the period were $85,000. There was a $5,000 ($90,000 – $85,000) favorable fixed GS&S variance.

37. End of Chapter 8