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Performance Evaluation Using Variances from Standard Costs

22. Performance Evaluation Using Variances from Standard Costs. Describe the types of standards and how they are established. 1. Compute and interpret direct materials and direct labor variances. Describe and illustrate how standards are used in budgeting.

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Performance Evaluation Using Variances from Standard Costs

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  1. 22 Performance Evaluation Using Variances from Standard Costs

  2. Describe the types of standards and how they are established. 1 Compute and interpret direct materials and direct labor variances. Describe and illustrate how standards are used in budgeting. Compute and interpret factory overhead and volume variances. 4 3 2 Learning Objective 1 Learning Objective 1 Performance Evaluation Using Variances from Standard Costs 3-1 3-1 After studying this chapter, you should be able to: Insert Chapter Objectives Describe the nature of the adjusting process. Describe the nature of the adjusting process. 22-2

  3. Journalize the entries for recording standards in the accounts and prepare an income statement that includes variances from standard. Describe and provide examples of nonfinancial performance measures. 5 6 Performance Evaluation Using Variances from Standard Costs (continued) 22-3

  4. 1 Describe the types of standards and how they are established. 22-4

  5. 1 Standards Standards are performance goals. Manufacturers normally use standard costs for each of the three product costs: • Direct materials • Direct labor • Factory overhead

  6. 1 Accounting systems that use standards for direct materials, direct labor, and factory overhead are called standard cost systems.

  7. 1 When actual costs are compared with standard costs, only the exceptions or variances are reported for cost control (called reporting by the principle of exceptions). Such reports allow management to focus on correcting the cost variances.

  8. 1 Setting Standards The standard-setting process normally requires the joint effortsof accountants, engineers, and other management personnel.

  9. 1 Types of Standards Unrealistic standards that can be achieved only under perfect operating conditions (such as no idle time, no machine breakdowns, no materials spoilage) are called ideal standards or theoretical standards.

  10. 1 Currently attainable standards, sometimes called normal standards,can beattained with reasonable effort. Standards set at this level allow for disruptions, such as material spoilage and machine breakdowns.

  11. 1 Currently Attainable and Ideal Standards

  12. 1 Reviewing and Revising Standards Standard costs should be periodically reviewed to ensure that they reflect current operating conditions. Standards should be revised when they no longer reflect operating conditions.

  13. 1 Criticisms of Standard Costs • Standards limit operating improvements by discouraging improvements beyond the standard. • Standards are too difficult to maintain in a dynamic manufacturing environment, resulting in “stale standards.” • Standards can cause workers to lose sight of the larger objectives of the organization by focusing only on efficiency improvements. (continued)

  14. 1 Criticisms of Standard Costs (continued) • Standards can cause workers to unduly focus upon their own operations to the possible harm of other operations that rely on them.

  15. 2 Describe and illustrate how standards are used in budgeting. 22-15

  16. 2 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

  17. 2 Exhibit 1 Standard Cost for XL Jeans

  18. 2 Budget Performance Report The report that summarizes actual costs, standard cost, and the differences for the units produced is called a budget performance report.

  19. 2 • A favorable 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 (at actual volumes).

  20. 2 Exhibit 2 Budget Performance Report

  21. 2 Manufacturing Cost Variance The total manufacturing cost variance is the difference between total standard costs and total actual cost for the units produced.

  22. 2 Exhibit 3 Manufacturing Cost Variances

  23. 2 Direct Materials Variance The total direct materials variance is separated into price and quantity variances.

  24. 2 Direct Labor Variance The total direct labor variance is separated into rate and time variances.

  25. 3 Compute and interpret direct materials and direct labor variances. 22-25

  26. Total Unfavorable Materials Variance 3 Direct Materials Variances Actual Direct Materials Cost = Actual Price × Actual Quantity Actual Direct Materials Cost = $5.50 × (7,300 sq. yards.) Actual Direct Materials Cost = $40,150 Standard Direct Materials Cost = Standard × Standard Quantity Standard Direct Materials Cost = $5.00 × (7,300 sq. yards.) Standard Direct Materials Cost = $37,150 Actual costs ($40,150) – Standard costs ($37,500) = $2,650

  27. 3 Direct Materials Price Variance Direct Materials Price Variance = (Actual Price – Standard Price) × Actual Quantity Direct Materials Price Variance = ($5.50 – $5.00) × 7,300 sq. yds. Direct Materials Price Variance = $3,650 Unfavorable Variance Western Rider paid $0.50 more per square yard of material than the standard.

  28. 3 Direct Materials Quantity Variance Direct Materials Quantity Variance = (Actual Quantity – Standard Quantity) × Standard Price Direct Materials Quantity Variance = (7,300 sq. yds. – 7,500 sq. yds. × $5.00 Direct Materials Price Variance = ($1,000) Favorable Variance Western Rider used 200 less square yards of material than the standard.

  29. 3 Exhibit 4 Direct Materials Variance Relationships Standard cost: Actual cost: Standard quantity × Standard price 7,500 × $5.00 = $37,500 Actual quantity × Actual price 7,300 × $5.50 = $40,150 Actual quantity × Standard price 7,300 × $5.00 = $36,500 Materials price variance Material quantity variance $3,650 U ($1,000) F Total direct materials cost variance $40,150 – $37,500 = $2,650 U

  30. 3 Example Exercise 22-1 Direct Materials Variances Tip Top Corp. produces a product that requires six standard pounds per unit. The standard price is $4.50 per pound. If 3,000 units required 18,500 pounds, which were purchased at $4.35 per pound, what is the direct materials (a) price variance, (b) quantity variance, and (c) cost variance? 22-30

  31. Follow My Example 22-1 For Practice: PE 22-1A, PE 22-1B 3 Example Exercise 22-1 (continued) • Direct materials price variance (favorable) ($2,775) [($4.35 – $4.50) × 18,500 pounds] • Direct materials quantity variance (unfavorable) • $2,250 [(18,500 pounds – 18,000 pounds) ×$4.50] • Direct materials cost variance (favorable) • ($525) [($2,775) + $2,250] or [($4.35 × 18,500 pounds) – ($4.50 × 18,000 pounds)] = $80,475 – $81,000 22-31

  32. Total Unfavorable Labor Variance 3 Direct Labor Variances Actual Direct Labor Cost = Actual Rate per Hour × Actual Time Actual Direct Labor Cost = $10.00 per hr. × 3,850 hrs. Actual Direct Labor Cost = $38,500 Standard Direct Labor Cost = Standard Rate per Hour × Standard Time Standard Direct Labor Cost = $9.00 per hr. × 4,000 hrs. Standard Direct Labor Cost = $36,000 Actual costs ($38,500) – Standard costs ($36,000) = $2,500

  33. 3 Direct Labor Rate Variance Direct Labor Rate Variance = (Actual Rate per Hour – Standard Rate per Hour) × Actual Hours Direct Labor Rate Variance = ($10.00 – $9.00) × 3,850 hours Direct Labor Rate Variance = $3,850 Unfavorable Variance If the actual direct labor rate for the units produced is less than the standard direct labor rate, the variance is favorable.

  34. 3 Direct Labor Time Variance Direct Labor Time Variance = (Actual Direct Labor Hours – Standard Direct Labor Hours) × Standard Rate per Hour Direct Labor Time Variance = (3,850 hours – 4,000 direct labor hours) × $9.00 Direct Labor Time Variance = ($1,350) Favorable Variance If the actual direct hours for the units produced exceeds the standard direct labor hours, the variance is unfavorable.

  35. 3 Exhibit 5 Direct Labor Variance Relationships Standard cost: Actual cost: Actual hours × Actual rate 3,850 × $10 = $38,500 Actual hours × Standard rate 3,850 × $9 = $34,650 Standard hours × Standard rate 4,000 × $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

  36. 3 Example Exercise 22-2 Direct Labor Variances Tip Top Corp. produces a product that requires 2.5 standard hours per unit at a standard hourly rate of $12 per hour. If 3,000 units required 7,420 hours at an hourly rate of $12.30 per hour, what is the direct labor (a) rate variance, (b) time variance, and (c) cost variance? 22-36

  37. Follow My Example 22-2 For Practice: PE 22-2A, PE 22-2B 3 Example Exercise 22-2 (continued) • Direct labor rate variance (unfavorable) • $2,226 [($12.30 – $12.00) × 7,420 hours] • Direct labor time variance (favorable) • ($960) [7,420 hours – 7,500 hours) ×$12.00] • Direct labor cost variance (unfavorable) • $1,266 [$2,226 + ($960)] or [($12.30 × 7,420 hours) – ($12.00 × 7,500 hours)] = $91,266 – $90,000 22-37

  38. 4 Compute and interpret factory overhead controllable and volume variances. 22-38

  39. 4 Factory overhead costs are more difficult to analyze than are direct labor and materials costs. This is because factory overhead costs have fixed and variable cost elements.

  40. 4 Factory Overhead Cost Budget Indicating Standard Factory Overhead Rate Exhibit 6

  41. $30,000 5,000 direct labor hours Factory Overhead Rate = 4 The Factory Overhead Flexible Budget Budgeted Factory Overhead at Normal Capacity Normal Productive Capacity Factory Overhead Rate = Factory Overhead Rate = $6.00 per direct labor hour

  42. $12,000 5,000 direct labor hours Fixed Factory Overhead Rate = 4 Fixed Factory Overhead Rate Budgeted Fixed Overhead at Normal Capacity Normal Productive Capacity Fixed Factory Overhead Rate = Fixed Factory Overhead Rate = $2.40 per direct labor hour

  43. $18,000 5,000 direct labor hours Variable Factory Overhead Rate = 4 Variable Factory Overhead Rate Budgeted Fixed Overhead at Normal Capacity Normal Productive Capacity Variable Factory Overhead Rate = Variable Factory Overhead Rate = $3.60 per direct labor hour

  44. Standard Hours for Actual Units Produced Variable Factory Overhead Rate × 4 Variable Factory Overhead Variances Variable Factory Overhead Controllable Variance Actual Variable Factory Overhead Budgeted Variable Factory Overhead = –

  45. $14,400 4 Variable Factory Overhead Variances Variable Factory Overhead Controllable Variance Actual Variable Factory Overhead Budgeted Variable Factory Overhead = – 4,000 direct labor hours × $3.60

  46. $14,400 Variable Factory Overhead Controllable Variance $10,400 – $14,400 = Variable Factory Overhead Controllable Variance $(4,000) Favorable Variance = 4 Variable Factory Overhead Controllable Variance Actual Variable Factory Overhead = –

  47. Follow My Example 22-3 $350 unfavorable $16,850 – [$2.20 × (3,000 units × 2.5 hours)] Follow My Example 6-1 For Practice: PE 22-3A, PE 22-3B 4 Example Exercise 22-3 Factory Overhead Controllable Variance Tip Top Corp. produced 3,000 units of product that required 2.5 standard hours per unit. The standard variable overhead cost per unit is $2.20 per hour. The actual variable factory overhead was $16,850. Determine the variable factory overhead controllable variance. 22-47

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

  49. 4 Exhibit 7 Graph of Fixed Overhead Volume Variance

  50. 4 Reasons for an Unfavorable Volume Variance • Failure to maintain an even flow of work • Machine breakdowns • Work stoppage caused by lack of materials or skilled labor • Lack of enough sales orders to keep the factory operating at normal capacity

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