flexible budgets, acctg 312 cost variances week 15 a … · flexible budgets, cost variances and...
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Learning objectives
At the end of this chapter, you should be able to:
1. Discuss how companies use standard-costing systems to manage costs and describe three ways to set standards.
2. Define and distinguish between perfection and practical standards.
3. Compute and interpret direct-material price and quantity variances, and direct-labour rate, and efficiency variances.
Learning objectives (continued)
4. Determine the significance of cost variances.
5. Discuss the behavioural effects of standard costing and discuss the controllability of variances.
6. Explain how companies use standard costs in product costing.
7. Summarize some advantages attributed to standard costing.
Analysis ofAnalysis ofHistorical
Data
TaskAnalysis
Used in a mature production
Process
Analyze the processof manufacturing
the product
What DIDthe
productcost?
What SHOULD
the product cost?
Approach
A CombinedApproach
Analyze the process for the step thathas changed, but use historical datafor the steps that have not changed
Setting Standards
Perfection Vs. Practical Standards
PERFECTIONSTANDARDS
PRACTICAL ORATTAINABLESTANDARDS
Can only be attained under near perfect conditions
Tight as practical,
attained
Tight as practical,but still are
expected to be attained
•Occasional machine
breakdowns•Normal amounts
of raw materialWaste
•Peak efficiency
production
•Peak efficiency•Lowest possible
input prices•best-quality
material•no disruption in
production
QuantityStandards
PriceStandards
Use product design specifications.
Use competitivebids for the quality
and quantity desired.
Setting Standards – Direct Materials
The standard material cost for one unit of product is:
standard quantitystandard price for of material
one unit of material required for one unit of product
×
Setting Standards – Direct Materials
In some manufacturing processes, a certain amount of defective production or spoilage is normal.
Example: 1,000 liters of chemicals are normally required in a chemical process in order to obtain 800 liters of good output. If total good output in February is 5,000 liters, what is the standard allowed quantity
of input?
Good output quantity = 80% X Input quantity
Good output quantity ÷ 80% = Input quantity allowed
5,000 liters of goodoutput ÷ 80%
= 6,250 liters of input allowed
Allowance For Defects Or Spoilage
EfficiencyStandards
RateStandards
Use time and motion studies for
each labor operation.
Use wage surveys and
labor contracts.
Setting Standards – Direct Labor
The standard labor cost for one unit of product is:
standard numberstandard wage rate of labor hours
for one hour for one unitof product
×
Setting Standards – Direct Labor
STANDARD COSTa budget for the
production of one unit of product or
service
ACTUAL COSTused in the
production of the product or service
COST VARIANCEthe differencebetween the
actual cost andthe standard cost
Using Standard-Costing Systems for Control
Favourable VariancesVariances are either favourable or adverse (unfavourable)
Favourable variances impact favourably on the profitExpense:when actual expenses is less than standardexpense, the variance is favourable
Revenue:when actual revenue is greater than standard revenue, the variance is favourable
Unfavourable VariancesUnfavourable or adverse variances impact
unfavourably on the profit
Expense:when actual expenses is greater than standardexpense, the variance is unfavourable
Revenue:when actual revenue is less than standardrevenue, the variance is unfavourable
Unfavourable Variances
Unfavourable variances measure a business's failure to meet its plans and large unfavourablevariances represent large failures.
It is worthwhile reporting a variance to a manager only if that manager can exercise some control over the cost (or revenue) being reported.
Broadly controllable costs should be those which the manager is responsible for budgeting.
Control through Management by ExceptionVariance analysis is a tool for alerting management to the fact that there are problems and narrowing down the sources.
It directs the scarce resource of management time to the areas where it is most needed.
The practice of using the variance analysis in this manner is called management by exception (MBE).
MBE refers to the process of delegating all routine functions by means of procedures and focusing management attention on only those items which fall outside those procedures.
Take the time to investigate only Take the time to investigate only significant cost variances
What is significant?
Depends on the Size of theOrganization
Organization
Depends on the Type of the Organization
Depends on Depends on the Production
Process
Management by Exception
??
What constitutes an exception?
How does a manager know when to follow up on a cost variance
and when to ignore it?
RULE OF THUMB:Investigate variances that are either greater than
$10,000 or greater than 10 percent of standard cost
Size of Variance
Absolute Amount Relative Amount
Management by Exception
MONTH VARIANCE % OF STANDARD COSTSeptember $6,000 F 6.0%October 6,400 F 6.4%November 3,200 F 3.2%December 6,200 F 6.2%
MONTH VARIANCE % OF STANDARD COSTSeptember $6,000 F 6.0%October 6,400 F 6.4%November 3,200 F 3.2%December 6,200 F 6.2%
None of the variances are greaterthan $10,000 or10%, but this varianceshould be investigated becauseit has occurred at a reasonablyhigh amount for four consecutivemonths
Standarddirect labourcost
is $100,000
Recurring Variances
None of the variances are greater than $10,000 or 10%, but this variance
should be investigated because it has an unfavorable trend.
Standarddirect labour
is $100,000
MONTH VARIANCE % OF STANDARD COSTSeptember $250 U 0.25%October 840 U 0.84%November 4,000 U 4.0%December 9,300 U 9.3%
MONTH VARIANCE % OF STANDARD COSTSeptember $250 U 0.25%October 840 U 0.84%November 4,000 U 4.0%December 9,300 U 9.3%
Trends
Quantity VariancePrice Variance
The difference betweenthe actual price and the
standard price
The difference betweenthe actual quantity andthe standard quantity
Standard Cost Variances
Cost Variance Analysis
Basic ConceptsA budget relates to the cost for the total activity, whereas standard relates to a cost per unit of activity.Static (Master) Budget – is based on the output planned at the start of the budget periodStatic-Budget Variance (Level 1) – the difference between the actual result and the corresponding static budget amountFavorable Variance (F) – has the effect of increasing operating income relative to the budget amountUnfavorable Variance (U) – has the effect of decreasing operating income relative to the budget amount
VariancesVariances may start out “at the top” with a Level 1 analysis. This is the highest level of analysis, a super-macro
view of operating results. The Level 1 analysis is nothing more than the difference between actual and static-budgetFurther analysis decomposes (breaks down) the Level 0 analysis down into progressively smaller and smaller components Answers: “How much were we off?”
Levels 2, and 3 examine the Level 1 variance into progressively more-detailed levels of analysis Answers: “Where and why were we off?”
Flexing variable costsThe variable costs can be calculated using the
original budget information but when this is not available, the budgeted variable costs are
adjusted in direct proportion to the change in volume. The new variable cost for each item can be determined
by dividing the budget cost (variable)by budget volume (to get cost per unit) and then multiplying by actual
volume
Standard Quantities allowedThe following information applies to a vehicle
production plant:
Budgeted production = 1,000 vehiclesBudgeted quantity of tyres per vehicle = 5Actual production = 960 vehiclesActual quantity of tyres that were used = 4,850Calculate:a) Budgeted quantity of tyres that could be usedb) Standard quantity of tyres that should have
been used for the actual production
Standard Quantities allowedBudgeted production = 1,000 vehiclesBudgeted quantity of tyres per vehicle = 5Actual production = 960 vehiclesActual quantity of tyres that were used = 4,850Calculate:a) Budgeted quantity of tyres that could be used =
1,000 x 5 = 5,000b) Standard quantity of tyres that should have
been used for the actual production= 960 x 5 = 4,800
Flexible BudgetFlexible Budget – shifts budgeted revenues and costs up and down based actual operating results (activities)Represents a blending of actual activities and budgeted dollar amountsWill allow for preparation of Level 2 and 3 variances Answers the question: “Why were we off?”
Level 2 VariancesWhat might have caused the sales-volume variance? Demand is not growing Competitors are taking market share The firm did not adapt its products to customer
preferences Quality problemsWhat causes flexible budget variances? Change in selling price Using more inputs (material and labor) than expected The inputs had a higher price per unit than expected
A General Model for Variance Analysis
Actual Quantity Actual Quantity Standard Quantity× × ×
Actual Price Standard Price Standard Price
Price or RateVariance
Quantity or Efficiency Variance
A General Model forVariance Analysis
Actual Quantity Actual Quantity Standard Quantity× × ×
Actual Price Standard Price Standard Price
Standard price is the amount that should have been paid for the resources acquired.
Price or RateVariance
Quantity or Efficiency Variance
Quantity or Efficiency Variance
Price or RateVariance
A General Model forVariance Analysis
Actual Quantity Actual Quantity Standard Quantity× × ×
Actual Price Standard Price Standard Price
Standard quantity is the quantityallowed for the actual good output.
A General Model forVariance Analysis
Actual Quantity Actual Quantity Standard Quantity× × ×
Actual Price Standard Price Standard Price
Materials price variance Materials quantity varianceLabor rate variance Labor efficiency varianceVariable overhead Variable overhead spending variance efficiency variance
AQ(AP - SP) SP(AQ - SQ)
AQ = Actual Quantity SP = Standard PriceAP = Actual Price SQ = Standard Quantity
Price or RateVariance
Quantity or Efficiency Variance
Koala Camp Gear Company in MelbourneAustralia has the following standard costs to manufacture one Tree Line tent:
Material cost: 12 square meters per tent at$8.00 per square meter
Labour costs: 2 standard hours per tent at $18.00per direct labour hour
Last month Koala purchased 40,000 square meters at $8.15 per square meter and used 36,400 squaremeters to make 3,000 tents.
Last month 5,900 direct labour hours were worked at $19.00 per hour to make 3,000 tents.
Material Variances (example)
Standard quantity:Fabric in finished product 11 sq. metersAllowance for normal waste 1 sq. metersTotal standard quantity required per tent 12 sq. meters
Standard quantity:Fabric in finished product 11 sq. metersAllowance for normal waste 1 sq. metersTotal standard quantity required per tent 12 sq. meters
Purchase price per sq. meter of fabric (net of purchase discounts) $7.75Transportation cost per sq. meter 0.25Total standard price per sq. meter of fabric $8.00
Purchase price per sq. meter of fabric (net of purchase discounts) $7.75Transportation cost per sq. meter 0.25Total standard price per sq. meter of fabric $8.00
Koala CampGear Company
DIRECT MATERIAL STANDARDS (practical not perfection)
The total amount of material normally required to
produce a finished product including allowances for
normal waste or efficiency
The total delivered
discounts
The total delivered cost, after subtracting
any purchase discounts
Cost Variance Analysis
Koala CampGear Company
DIRECT LABOR STANDARDSDIRECT LABOR STANDARDS
Standard quantity:Direct labor required per tent 2 hoursStandard rate:Hourly wage rate $15Fringe benefits (20% of wages) 3Total standard rate per hour $18
Standard quantity:Direct labor required per tent 2 hoursStandard rate:Hourly wage rate $15Fringe benefits (20% of wages) 3Total standard rate per hour $18
Cost Variance Analysis
Direct material: Standard direct-material cost per tent (12 sq. meters x $8 pr sq. meter) $96Actual output x3,000Total standard direct-material cost $288,000
Direct material: Standard direct-material cost per tent (12 sq. meters x $8 pr sq. meter) $96Actual output x3,000Total standard direct-material cost $288,000
Direct labor:Direct labor cost per tent (2 hours x $18 per hour) $36Actual output X 3,000Total standard direct-labor cost $108,000
Direct labor:Direct labor cost per tent (2 hours x $18 per hour) $36Actual output X 3,000Total standard direct-labor cost $108,000
Koala CampGear Company
The standard cost forthe direct-material
and direct-labor inputsis based upon Koala’s
actual output of 3,000 tents
They should incura cost of $396,000
($288,000 + $108,000)to make 3,000 tents
Standard Costs Given Actual Output (overview)
Standard cost:
12 square meters per tent at$8.00 per square meter
purchased 40,000 square meters at $8.15per square meter and
used 36,400 square meters to make 3,000 tents.
Material Variances (detailed)
We should compute the price variance using the actual
quantity purchased.
Price variance$6,000 Unfavorable
40,000 sqm. 40,000 sqm. × ×
$8.15 per sqm. $8.00 per sqm.
$326,000 $320,000
Actual Quantity Actual QuantityPurchased Purchased
× ×Actual Price Standard Price
Material Variances
We should compute the quantity variance
using the actual quantity used.
Quantity variance$3,200 Unfavorable
36,400 sqm. 36,000 sqm.× ×
$8.00 per sqm. $8.00 per sqm.
$291,200 $288,000
Actual QuantityUsed Standard Quantity
× ×Standard Price Standard Price
SQ = 3,000 tents × 12 sqm. per tentSQ = 36,000 sqm.
Material Variances
MPV = AQp(AP – SP)MPV = 40,000 sqm. × ($8.15 – $8.00)MPV = $6,000 Unfavorable
MQV = SP(AQu – SQ)MQV = $8.00(36,400 sqm. – 36,000 sqm.)MQV = $3,200 Unfavorable
We may also calculate materialvariances using formulas:
Material Variances
40,000 sq.meters
purchased
$8.15 persq. meter
40,000 sq.meters
purchased
$8.00 persq. meter
36,000sq. meters
allowed
$8.00 per sq. meter
$326,000 $320,000 $288,000
$6,000U
36,400 sq.meters
used
$8.00per sq.meter
$291,200
Direct-material price variance
$3,200U
Direct-materialquantity variance
xx x
Analysis Of Material VariancesActual
quantityActualprice
Actualquantity
Standardprice
Standardquantity
Standardpricexx x
What caused Koala to spend more than theanticipated amount on direct material?
First, the company purchased fabric at a higher price ($8.15 persquare meter) than the standard price ($8.00 per square meter).
Direct-material price variance = (PQ X AP) - (PQ X SP) = PQ(AP - SP) where: PQ = Quantity purchased
AP = Actual priceSP = Standard price
Koala’s direct- material price variance for June is computed as follows:Direct-material price variance = PQ(AP - SP)= 40,000 ($8.15 - $8.00) = $6,000 unfavorable
Direct-Material Variances
Second, the company used more fabric than the standard price. (36,400 sq. meters actually used, Instead of the standard amount of 36,000 sq. meters)
Direct-material quantity variance =(AQ X SP) - (SQ X SP) = SP(AQ - SQ) where:
AQ = Actual quantity used SQ = Standard quantity allowed
Koala’s direct- material quantity variance for June
=$3,200 unfavorable
Koala’s direct- material quantity variance for June is computed as follows:
Direct-material quantity variance = SP(AQ - SQ)= $8.00(36,400 - 36,000)
=$3,200 unfavorable
What caused Koala to spend more than theanticipated amount on direct material?
Direct-Material Variances
Koala has the following direct laborstandard to manufacture one Tree Line tent:
2 standard hours per tent at$18.00 per direct labor hour
Last month 5,900 direct labor hours were worked at $19.00 per hour to make 3,000 tents.
Labor Variances (detailed)
Actual Hours Actual Hours Standard Hours× × ×
Actual Rate Standard Rate Standard Rate
Rate variance$5,900 Unfavorable
Efficiency variance$1,800 Favorable
5,900 hours 5,900 hours 6,000 hours× × ×
$19.00 per hour $18.00 per hour $18.00 per hour
$112,100 $106,200 $108,000
SH = 3,000 tents × 2 hours per tentSH = 6,000 hours
Labor Variances
LRV = AH(AR - SR)LRV = 5,900 hrs($19.00 - $18.00)LRV = $5,900 Unfavorable
LEV = SR(AH - SH)LEV = $18.00(5,900 hrs - 6,000 hrs)LEV = $1,800 Favorable
We may also calculate laborvariances using formulas:
Labor Variances
Labor Rate Variance –A Closer Look
Production managers who make work assignmentsare generally responsible for price variances.
High skill,high rate
Low skill,low rate
Using highly paid skilled workers toperform unskilled tasks results in an
unfavorable price variance.
Labor Efficiency Variance –A Closer Look
UnfavorableEfficiencyVariance
Poorlytrainedworkers
Poorquality
materials
Poorlymaintainedequipment
Poorsupervisionof workers
Labour rate and efficiency variances (summary)
For the rate variance, the rate should vary between standard and actual rate. And this difference is multiplied by the actual timeFor the efficiency variance, the time should vary between standard and actual time. And this difference is multiplied by the standard rate.
X X X
Actual Labor Cost Standard Labor CostActualhours
Standardprice
Actualrate
Actualhours
Standardrate
StandardrateXXX
5,900 hoursused
$19per
hour
5,900hoursused
$18per
hour
6,000 hours
allowed
$18 per
hour
$112,100 $106,200 $108,000
$5,900 Unfavorable $1,800 FavorableDirect-laborrate variance
Direct-laborefficiency variance
$4,100 Unfavorable
Direct-labor variance
Analysis of Direct-Labour Variances
What caused Koala to spend more than theanticipated amount on direct labor?
Direct instead of the standard amount of $18 per hrFirst, the company incurred a cost of $19 per hour for
Direct labour instead of the standard amount of $18 per hr
Direct-labor rate variance = (AH X AR) - (AH X SR) =
SR = Standard rate per hour
Direct-labor rate variance = (AH X AR) - (AH X SR) =AH(AR - SR) where:
AH = Actual hours used AR = Actual rate per hour
SR = Standard rate per hour
Koala’s direct-labor rate variance for June is computed as follows:
Direct-labor rate variance = AH(AR - SR)= 5,900 ($19 - $18)
=$5,900 unfavorable
Direct-Labour Variances
Koala used only 5,900 hours of direct labour, which is <
offset the unexpectedly high wage rate.
Koala used only 5,900 hours of direct labour, which is < standard quantity of 6,000 hours, given actual output of
3,000 tents. The increased efficiency does not fully offset the unexpectedly high wage rate.
Direct-labour efficiency variance = (AH X SR) - (SH X SR) =
SH = Standard hours allowed
Direct-labour efficiency variance = (AH X SR) - (SH X SR) =SR(AH - SH) where:
AH = Actual hours used SH = Standard hours allowed
Koala’s direct - labour efficiency variance for June is computed as follows:
Direct - labor efficiency variance = SR(AH - SH)= $18 (5,900 - 6,000) = $1,800 favorable
anticipated amount on direct labour?What caused Koala to spend more than the
anticipated amount on direct labour?
Direct-Labour Variances
Direct material X $1,500 F $1,900 UDirect material Y 2,400 U 300 UDirect material Z 900 U 400 FTotal variance $1,800 U $1,800 U
Direct material X $1,500 F $1,900 UDirect material Y 2,400 U 300 UDirect material Z 900 U 400 FTotal variance $1,800 U $1,800 U
When there are several types of direct material or direct labour, price and quantity variances are computed for
each type, and then added to obtain a total price variance and a total quality variance
Multiple Types Of Direct Material Or Direct Labour
Mix and yield variances
The quantity variance can be sub-divided into a mixture variance and a yield variance where more than one type of raw material is used for the manufacture of a product. The total of the two latter variances should however add up to the quantity Variance.
one that is not
ControllabilityA manager is more likely to investigate a variance that is controllable by someone in the
organization than one that is not
Favorable VariancesIt is as important to
investigate significant favorable variances as well as
significant unfavorable variances
Cost and Benefits of Investigation
The decision whether to investigate a variance is a
cost - benefit decision
Additional Issues
Behavioural Effects Of Standard Costing
Standard costs, budgets, and variances areused to evaluate the performance of
individuals and departments
They can profoundly influence behavior whenthey are used to determine salary increases,
bonuses, and promotions
Direct-material price variance
Direct-material quantity variance
Direct-labor rate variance
Direct- labor efficiency variance
The purchasing manager
The production supervisor
The production supervisor
The production supervisor
Get the best prices available for purchased goods and services throughskillful purchasing practices
Skillful supervision and motivation of production employees, coupled withthe careful use and handling of materials, contribute to minimal waste
Generally results from using a different mix of employees than that anticipatedwhen the standard were set
Motivating employees toward production goals and effective work schedulesimproves efficiency
Which Managers Generally Influence Cost Variances?
Variances are temporary
accounts, like revenue and
expense accounts, and
they are closed out at the end of the
accountingperiod.
Cost of Goods Sold
Unfavorablevariancesrepresentcosts of
operatinginefficiently,
relative to thestandards, and
thus cause the Cost ofGoods Sold
to be higher
Favorablevariancesrepresentcosts of
operatingefficiently,
relative to thestandards, and
thus cause the Cost ofGoods Sold
to be lower
Disposition Of Variances
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