To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11 Standard Costs and Variance Analysis LEARNING OBJECTIVES Chapter 11 addresses the following questions: Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 How are standard costs established? What is variance analysis, and how is it performed? How are direct cost variances calculated? How is direct cost variance information analyzed and used? How are variable and fixed overhead variances calculated? How is overhead variance information analyzed and used? How are manufacturing cost variances closed? Which profit-related variances are commonly analyzed? (Appendix 11A) These learning questions (Q1 through Q8) are cross-referenced in the textbook to individual exercises and problems COMPLEXITY SYMBOLS The textbook uses a coding system to identify the complexity of individual requirements in the exercises and problems Questions Having a Single Correct Answer: No Symbol This question requires students to recall or apply knowledge as shown in the textbook This question requires students to extend knowledge beyond the applications e shown in the textbook Open-ended questions are coded according to the skills described in Steps for Better Thinking (Exhibit 1.10):  Step skills (Identifying)  Step skills (Exploring)  Step skills (Prioritizing)  Step skills (Envisioning) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 11-2 Cost Management QUESTIONS 11.1 Managers need information about the costs of direct materials and direct labor as well as whether direct materials and labor have been used efficiently If the price and efficiency variances are combined, it is impossible to separate the causes of the variance into potential changes in prices of direct materials (or the labor hourly wage) and changes in the amount of materials (or labor hours) used to manufacture the product Managers need specific information to better monitor operations and investigate changes 11.2 Utilities are considered fixed costs These include phone service, natural gas, and electricity The use of natural gas and electricity is affected by weather patterns Because weather patterns change, these costs cannot be perfectly predicted There may be unanticipated price changes in the cost of utilities In addition, employees could be careless in their use of electricity or telephones Therefore, variances occur regularly 11.3 GAAP requires that revenues and expenses be matched Revenues from the sales of units must be matched to the costs of producing those same units When a standard cost system is used, production costs are recorded at standard rather than at actual costs At the end of the accounting period adjusting entries are made to close the variance accounts and to distribute the amounts to inventory and cost of goods sold These entries simultaneously close the variance accounts and adjust inventory and cost of goods sold to reflect actual costs for the period 11.4 For a simple but meaningful variance report for costs, the following variances should be calculated Price and efficiency variances for direct materials and direct labor provide information about price changes, purchasing efficiencies and the use of materials Managers can correct some of these problems to insure cost-effective production The variable overhead spending variance and the fixed overhead budget variance provide information about whether costs are being kept under control The efficiency variance for variable overhead and production volume variances not provide any incremental information about whether inputs were purchased or used efficiently 11.5 At the end of the accounting period, the following variances need to be recorded: direct materials and direct labor price and efficiency variances, variable overhead spending variance, fixed overhead budget variance, variable overhead efficiency variance, and production volume variance If the sum of these is immaterial, it is closed to cost of goods sold If the sum is material, it is prorated across inventory and COGS 11.6 Managers monitor variances that are large and unexpected Sometimes a minimum dollar amount is set as a criteria so that only variances greater than that amount are investigated Managers make trade-offs between the costs of investigating and the benefit from improving the process or standard Trends in variances also may affect whether a To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11: Standard Costs and Variance Analysis 11-3 variance is investigated If accountants know a variance is increasing over time, they may decide to investigate to identify ways to reverse a negative trend or to modify future standards for a positive trend 11.7 The cost categories that are measured and monitored in a given organization depend on several factors, including the following: Nature of goods or services: Manufacturers monitor input prices and efficiency of labor and materials, whereas service organizations monitor cost per service provided, which may not include materials All organizations monitor fixed costs, although the type of fixed costs varies widely with the type of business Cost accounting system used: The cost categories will be more precise with more complex cost accounting systems An organization with an ABC system that separates costs into flexible and committed categories could develop standards and measure variances for every activity performed Alternatively, only broad categories may be tracked, such as the traditional direct materials and direct labor categories Costs that managers consider important: Overhead costs are often aggregated together and include indirect costs such as oil for machine maintenance While these costs may not be individually important, they are often monitored as part of the larger category of overhead costs Cost/benefit trade-off for monitoring individual costs: For those costs already reported by the accounting system, such as direct labor in a job costing system, the cost to develop standards and monitor variances is probably low, and the benefit could be relatively high if such monitoring encourages labor to be more efficient However, other costs, indirect materials used during set-ups, may be expensive to track The benefit from tracking these costs may be low if only very small amounts of materials are used per set-up These costs are likely to be aggregated into overhead 11.8 Standard costs are often set using the most recent year’s data Historical trends may be analyzed and used Sometimes industrial engineers develop standards by analyzing the manufacturing or service delivery process 11.9 Recurring favorable variances may indicate that some process has improved These should be investigated so that standard production practices reflect the process improvements Variances may also reflect opportunities to examine the manufacturing process and quality of materials to determine improvements Sometimes the standard is wrong, and the monitoring process is improved by changing the standard to reflect current operations 11.10 The contribution margin variance calculates the effects of changes in contribution margins, given the actual level of sales The contribution margin sales volume variance calculates the effects of changes in units sold, given the standard contribution margins This information helps managers focus on the reason that the contribution margin is To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 11-4 Cost Management changing Managers may want to focus on the underlying variable costs, or pricing, or consider product emphasis These variances help determine whether it’s a change in the volume of sales, or change in the price or variable cost that causes the variance When sales are slow, prices could be lowered, which would be reflected in the contribution margin variance These types of changes should be investigated 11.11 The sales price variance reflects the difference between standard and actual selling prices for the volume of units actually sold This variance is favorable if the actual selling price exceeds the standard price, and it is unfavorable if the reverse is true The revenue sales quantity variance reflects the difference between the standard and actual quantity of units sold at the standard selling price This variance will be favorable when actual quantities exceed standard quantities, and it will be unfavorable otherwise These variances help managers determine whether changes in revenues are driven by changes in selling price or changes in quantities sold To remedy any problems, this information is quite useful 11.12 When the direct materials price variance is large and favorable while direct materials efficiency variance is large and unfavorable, it is possible that lower quality materials are being purchased This could have a negative effect on the efficiency variance if defective materials are being discarded Both purchasing and production personnel should be asked whether there has been a change in the quality of materials purchased Production personnel should also be asked to explain the unfavorable efficiency variances 11.13 If the direct material price variance is recorded at the time of purchase, direct materials are recorded in inventory at standard cost and not need to be tracked by purchase date and purchase price This reduces bookkeeping time and effort and simplifies inventory control It also clarifies that the price variance occurs at the time of purchase rather than at the time direct materials are used To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11: Standard Costs and Variance Analysis 11-5 EXERCISES 11.14 Kitchen Tile Company A This question requires a missing piece of information: the actual number of hours worked However, because the labor efficiency variance is given, the variance formula can be used to solve for actual labor hours as follows: Labor efficiency variance = (Standard hours – Actual hours)* Standard price The variance amount is given as $6,720 Favorable, and the standard labor price is given as $24.00 per hour The number of standard labor hours is calculated as follows: Actual production = 18,000 tiles Standard efficiency is tiles per labor hour Standard number of labor hours for 18,000 tiles: = 18,000 tiles/6 tiles per hour = 3,000 hours Now solve for actual labor hours using the variance formula: $6,720 = $24.00 * (3,000 hours – Actual hours) $6,720/$24 = 3,000 – Actual hours 280 = 3,000 – Actual hours Actual hours = 3,000 – 280 = 2,720 Quicker approach: The efficiency variance represents the amount by which actual hours exceed standard hours, times the standard price This means that the efficiency variance represents 280 hours ($6,720/$24) Because the variance was favorable, 280 fewer hours were used than the standard required For 18,000 tiles, standard labor hours are 3,000 (18,000/6) Therefore, actual hours are 3,000 – 280 = 2,720 hours B The direct labor price variance is calculated using the following formula: Actual labor hours * (Standard price – Actual price) = 2,720 hours * ($24.00 - $24.50) = $(1,360) Unfavorable C The fixed overhead budget (i.e., spending) variance is calculated by simply taking the difference between standard and actual fixed costs: Standard fixed costs – Actual fixed costs = $60,000 - $58,720 = $1,280 Favorable To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 11-6 Cost Management 11.15 Nakatani Enterprises A Standard costs for actual output of 15,342 units: Direct materials (15,342 units x 0.8 lbs x $2.00/lb.) Direct labor (15,342 units x 0.2 hrs x $17.00/hour) Total $24,547.20 52,162.80 $76,710.00 B Direct materials price variance Standard cost for actual purchases ($2.00/lb x 11,000 lbs.) Actual cost of purchases Price variance $22,000 21,730 270 F $ C Direct materials efficiency variance Standard quantity of materials for actual output (15,342 x 0.8 lbs.) 12,273.6 lbs Actual quantity of materials used 13,252.0 lbs Variance in pounds (978.4) lbs Times standard cost per pound $2 Efficiency variance $(1,956.80) U D Direct labor price variance Standard cost for actual labor hours ($17 x 2,730 hours) Actual labor cost Price variance E Direct labor efficiency variance Standard labor hours for actual output (15,342 x 0.2 hours) Actual labor hours Variance in hours Times standard cost per hour Efficiency variance $ $46,410 47,000 (590) U 3,068.4 2,730.0 338.4 hours $17 $5,752.80 F F If managers use 10% of total direct costs as the criteria for investigation, none of these variances would be investigated However, the direct labor efficiency variance is relatively large compared to total direct labor cost at 11% ($5,752.80/$52,162.80) Some managers may want to investigate this variance, especially if this company is concerned about quality as a strategy If quality has decreased as a result of this favorable variance, defective or low quality units could affect Nakatani’s reputation and future revenues if customers are disgruntled If production processes have improved, and there is no adverse change in quality, so managers might want to change the labor quantity standard To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11: Standard Costs and Variance Analysis 11-7 11.16 Nell Company A Direct material price variance [($0.20 - $0.17) x 100,000] Direct material efficiency variance [(5 * 10,000 - 60,000) x $0.20] Direct labor price variance [($7.00 - $7.20) x 3,900] Direct labor efficiency variance [(0.4 * 10,000 - 3,900) x $7.00] B Journal entries: Raw materials inventory (100,000 lbs at $0.20/lb.) Direct materials price variance Accounts payable Work in process inventory (5*10,000*$0.20) Direct materials efficiency variance Raw materials inventory (60,000 * $0.20) Work in process inventory (0.4*10,000*$7.00) Direct labor price variance Direct labor efficiency variance Wages payable (3,900 * $7.20) $3,000 F 2,000 U 780 U 700 F $20,000 $3,000 $17,000 $10,000 $2,000 $12,000 $28,000 $780 $700 $28,080 11.17 Derf Company Standard fixed overhead is $135,000 x 0.20 = $27,000 Standard variable overhead is $135,000 x 0.80 = $108,000 The standard fixed overhead allocation rate is $27,000/(9,000 x 2) = $1.50 per hour The standard variable overhead allocation rate is $108,000/(9,000 x 2) = $6.00 per hour A The variable overhead spending variance is: [$6.00 – ($108,500/17,200)] x 17,200 = $5,300 U B The variable overhead efficiency variance is: [8,500 * - 17,200] x $6 = $1,200 U C The fixed overhead spending (budget) variance is: $27,000 - $28,000 = $1,000 U D The fixed production volume variance is: $1.50 x [(8,500 x 2) – (9,000 x 2)] = $1,500 U To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 11-8 Cost Management E Journal entries Variable overhead cost control (actual cost) Accounts payable and other accounts Work in Process inventory (8,500 x hrs x $6/hr) Variable overhead cost control Variable overhead spending variance Variable overhead efficiency variance Variable overhead cost control $108,500 $108,500 102,000 102,000 $5,300 $1,200 $6,500 Fixed overhead cost control Accounts payable and other accounts $28,000 WIP inventory (8,500 x x $1.50) Fixed overhead cost control $25,500 $28,000 $25,500 Fixed overhead spending (budget) variance Production volume variance Fixed overhead cost control $1,000 $1,500 Ending WIP, finished goods, and/or COGSa Variable overhead spending variance Variable overhead efficiency variance Fixed overhead spending (budget) variance Production volume variance $9,000 a $2,500 $5,300 $1,200 $1,000 $1,500 The total variance of $9,000 would be prorated based on the ending balances in work-in-process inventory, finished goods inventory, and cost of goods sold 11.18 Mitchellville Products Company A Revenue budget variance = $60,000 – $53,200 = $6,800 Unfavorable B Sales price variance: Standard unit price = $60,000/4,000 = $15 Actual unit price = $14 Sales price variance = ($15 - $14) x 3,800 = $3,800 Unfavorable C Revenue sales quantity variance = (4,000 – 3,800) x $15 = $3,000 Unfavorable To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11: Standard Costs and Variance Analysis 11-9 D The standard contribution margin is Sales Less: Variable manufacturing Variable selling and administration Contribution margin $60,000 16,000 8,000 $36,000 Because contribution margin represents 4,000 units, the contribution margin per unit must be $36,000/4,000 = $9 Then, the contribution margin sales volume variance is $9 x (4,000 - 3,800) = $1,800 U 11.19 Metropolitan Motors A The contribution margin budget variance is the difference between the standard contribution margin and the actual contribution margin First, calculate the contribution margin at budget: Economy Family Luxury (10*$400) (20*$800) (5*$1,300) $ 4,000 16,000 6,500 $26,500 The average contribution margin per sale is $26,500/35 = $757.14 The actual contribution margin is Economy Family Luxury Total 25 10 38 $ 5,625 7,500 4,200 $17,325 The average contribution margin per sale is $17,325/38 = $455.92 Contribution margin budget variance = $9,175 U because the contribution margin is less than standard To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 11-10 Cost Management B The contribution margin variance reflects the effects of the change in contribution margin, given the actual level of sales First calculate what the contribution margin would have been at actual sales and standard contribution margin: Economy Family Luxury 25 x $400 10 x $800 x $1,300 38 $10,000 8,000 3,900 $21,900 The average contribution margin at actual sales mix, standard contribution margin is $21,900/38 = $576.32 Then take the difference between this and the actual contribution margin Contribution margin variance = $21,900 - $17,325 = $4,575 U The contribution margin sales volume variance is the difference between the standard volume, mix, and contribution margin and the actual mix and volume at standard contribution margin or $21,900 - $26,500 = $4,600 U Check: The two variances should equal the contribution margin budget variance $9,175U = $4,575 U + $4,600 U C The contribution margin sales quantity variance is the difference in actual quantity sold and the standard quantity, given the standard sales mix and standard contribution margin The average contribution margin at standard sales mix and standard contribution margin was calculated above in part A (35 - 38) * $757.14 = $2,271.42 F The contribution margin sales mix variance is the difference between the standard sales mix and the actual sales mix given actual sales at standard contribution margin This can be calculated two different ways The actual units and actual sales mix at standard contribution margin total is $21,900 The actual units at standard sales mix and standard contribution margin is $757.14 * 38 = $28,771.32 So the total variance = $21,900 $28,771 = $6,871.32 U Alternatively, the averages from above can be used as follows Contribution margin sales mix variance = ($757.14 - $576.32)*38 = $6,871.16 U These two variances should sum to the contribution margin sales volume variance of $4,600, and they ($6,871 - $2,271 = $4,600) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 11-24 Cost Management The manager should be praised The net effect of the manager's changes can be seen in the sales mix, quantity, and price variances These variances total to an $88,000 favorable variance ($32,538.46 U + $86,538.46 F + $56,000.00 F + $22,000.00 U) C Sales Games (55,000*35,000/50,000) @ $17.60 Business (55,000*4,000/50,000) @ $49.50 Educational (55,000*11,000/50,000) @ $20.00 Total sales Variable costs 55,000 @ $1.80 Fixed costs Pretax income $ 677,600 217,800 242,000 1,137,400 99,000 535,000 $ 503,400 D The managers cannot know for certain whether there will be changes in customer preferences that affect the demand estimates They also cannot know for certain when prices of inputs will increase Although they can build known price changes into the budget, even vendors may not anticipate their own price increases up to a year in the future The managers cannot know their costs for services such as electricity and transportation because these prices are affected by weather and gas and oil costs There are many uncertainties that cannot be perfectly predicted; these are just a few examples 11.30 Professor Grader A It is not possible to develop a perfect system for measuring student performance in a course To know for certain the amount of effort put forth, and the understanding that each student acquires, a professor would have to monitor all of their actions related to the course, no matter where the student was This is impossible Even if it were possible to perfectly observe all student actions, uncertainty would still exist about how best to measure individual course performance Should students be graded based on the improvement in their knowledge and other competencies during the course? Should they be graded based on an absolute standard for the course? Should grades be measured relative to other students in the same section or several sections taught by the professor? B There is probably wider variation in exam results than any of the other measures, but because some students have access to the exam, variation is reduced There is probably very little variation in attendance because it is rarely monitored There is probably little variation in the term paper because it is graded on quantity, not quality, and the quantity standards are known by all students There is probably little variation on the take-home exam because students have two weeks to work on it, and judging from other aspects of this professor’s performance evaluation systems, it is likely that all of the questions have single correct answers because they are easy to grade C As a performance measurement system, the grading system is faulty for several reasons The performance standard appears to be very low Students will not be motivated to work hard to learn the subject matter of the course To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11: Standard Costs and Variance Analysis 11-25 The performance measurement for the term paper does not seem to be consistent with the goals of the course Measuring length instead of content would normally not measure whether students understood the subject matter of the course There is no feedback on the midterm exam Consequently, students are not apprised of whether they are meeting the standards of the course They have no basis for changing their actions to improve future performance The performance measure is unfair to the extent that some students have access to the midterm exam and others not It is questionable whether a student’s performance on the final exam provides information about overall performance The potential for manipulation (having someone else work the final) is high The defects in the performance measure are so severe that one should not attempt to use grades earned in this course as a measure of students' comprehension of the subject matter D Professor Grader has a responsibility to students and to others who directly finance students (such as parents and spouses) to grade in a manner that is consistent with university and program policies and also with the grading system set forth in the course syllabus The professor is also responsible for establishing a grading system that is fair to students in the course and that measures student learning (although how to this is uncertain, as described in Part A) This group of stakeholders often considers grades as signals about student effort and/or ability If the grades not measure student effort or ability, even with error, these stakeholders not have adequate information about the student’s progress Professor Grader has responsibilities toward the recruiters who hire the university’s graduates Recruiters want to identify students who work hard and learn new things quickly Grades measure these skills and abilities, although with error Without appropriate measurement, recruiters cannot identify students that might best suit their needs, and they may no longer use the university for recruiting Professor Grader is responsible to the university, which expects professors to ensure that graduating students have met outcomes specified by the university, such as the ability to think critically, communicate effectively, be an effective team member, and are knowledgeable within their respective majors Universities rely on professors and their evaluation systems to maintain standards Professor Grader is responsible to other professors at the university, who rely on their colleagues to grade fairly so that students develop a better understanding of expectations and are not become unhappy about discrepancies in grades across courses or sections of courses To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 11-26 Cost Management Professor Grader is responsible to state and federal governments and their citizens, who financially support the university, for using resources efficiently The professor is responsible to these stakeholders for ensuring that the grading system encourages greater student learning The professor also has a responsibility to the general public for improving the education of its citizens E There are a variety of ways to answer this question In general, however, Professor Grader does not appear to have acted ethically in this situation because the professor does not appear to have adequately addressed the responsibilities described in Part D The professor appears to have placed low priority on values such as integrity, fairness, and professional competence F It is unethical for students to cooperate on the take-home exam if Professor Grader has specifically asked them not to that It is also unethical for students to have access to an exam that is not public information Some students in the class will act ethically because they have high ethical standards It is unfair to these students when other students no behave ethically Some students in this situation might rationalize unethical behavior by saying that “Everyone is doing it,” or “The professor should expect us to get all the help we can.” These types of rationalizations are simply ways of avoiding ethical responsibility Although the professor’s system might contribute to unethical behavior, the system does not justify unethical behavior A variety of values could be used to reach the conclusions drawn above For example, the values of fairness, honesty, and integrity would lead students to behave ethically in this situation 11.31 Benerux Industries A Managers cannot perfectly observe employee effort and abilities Therefore, it is impossible to perfectly measure, monitor, and motivate employee performance B The first part of the performance measurement system allows company managers to learn whether the company’s production levels this year are 5% higher than production levels during the same month of the prior year The second part of the performance measurement system allows the managers to learn whether actual cost per unit is higher or lower than the average cost for manufacturing this kind of product as determined from industry newsletters C In companies that value quality, price and efficiency variances may not be as important as information about quality If the company’s strategy is to be the highest quality manufacturer, and the market is willing to pay more for higher quality, the company may emphasize quality and may not emphasize cost control and efficiency To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11: Standard Costs and Variance Analysis 11-27 D The proposed performance measurement report suffers from several major weaknesses It concentrates on the wrong goals quantity and cost The firm has achieved its success through quality The volume measure is susceptible to easy manipulation Production employees could presumably start a large number of units with virtually no effort This would increase the amount of WIP on hand and increase inventory carrying costs The performance standard on quantity is arbitrary (5% increase) It seems unrelated to sales and may encourage the accumulation of excess inventory The performance standard for cost is incorrect The firm is producing a higher quality product than other firms in the industry Consequently, the firm should expect higher costs than other firms Even if the reports were appropriate, a quarterly report is unlikely to provide sufficiently timely feedback to allow workers to adjust their performance to achieve budgeted goals Workers are likely to resent the new system and could then leave the company, requiring increased costs in training and reduced productivity E There is no single answer to this question However, the answer should contain a synthesis of the issues discussed in the preceding sections, and it should also address concerns about responding in a productive way to the new accountant The following major areas should be addressed: A summary of what the proposed system would measure (Part B) and the weaknesses in the proposal (Part D), followed by a conclusion about whether the CFO would support the proposal Most likely, the CFO would not be in favor of the proposal because it focuses on inappropriate measures A discussion of whether a new performance measurement system would be useful for this company This discussion would address possible reasons why variances are not currently used (Part C), followed by a conclusion about whether some type of new performance measurement system should be considered One possible conclusion would be that no apparent reason currently exists to make a change The company’s current control system seems to be working fine, so there may be no reason to consider changing it An alternative conclusion might be that it would be useful for the company to investigate possible alternative performance measures Even if the company’s system is working fine, there may be ways to improve it or to prevent unforeseen future problems; a performance measurement system might be useful Identify ways to respond to the new accountant The response should be positive so that it encourages the accountant to continue to think creatively and to share To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 11-28 Cost Management new ideas The response is also a learning opportunity for the new accountant The CFO could discuss the proposal with the cost accountant and ensure that the accountant understands the proposal’s flaws They could then discuss ways to improve upon the ideas in the proposal 11.32 Auto Parts Co A sample spreadsheet showing the calculations for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg) A Below is an excerpt from a sample spreadsheet for this problem For variable costs, the flexible cost budget should reflect the actual volume, or 950 pistons Because fixed costs are not expected to vary with production volume, they are presented using the static budget amount The problem information indicates that direct labor is a fixed cost Also, notice that the allocation base for variable factory overhead is direct labor hours FLEXIBLE COST BUDGET Variable costs: Piston shaft Shaft housing Variable factory overhead Variable selling & administration Fixed costs: Direct labor Fixed factory overhead Fixed selling & administrative Total Volume 950 950 397 950 Cost Rate $35 $20 $10 $10 Total $33,250 19,000 3,970 9,500 6,000 20,000 50,000 $141,720 The problem does not give the total standard amount of fixed direct labor cost or fixed factory overhead, but they can be calculated from the standard cost information: Fixed direct labor (1,000 pistons x $6 per piston) Fixed factory overhead (1,000 pistons x $20 per piston) $ 6,000 20,000 B The direct costs consist of: piston shafts, shaft housings, and direct labor Because the information in the problem indicates that actual costs were identical to standard costs for shaft housings, there are no variances for shaft housings Therefore, direct cost variances are calculated only for piston shafts and direct labor Also note that direct labor in this problem is treated as a fixed cost Accordingly, budget and volume variances are calculated for direct labor using the same method that is used for fixed factory overhead Below is an excerpt from a sample spreadsheet showing the direct cost variances for this problem To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11: Standard Costs and Variance Analysis 11-29 DIRECT COST VARIANCES Quantity Piston shaft direct materials price variance: Actual quantity @ standard price 1,000 Actual purchase cost 1,000 Favorable (Unfavorable) Standard Piston shaft direct materials efficiency variance: Standard quantity @ standard price 950 Actual quantity @ standard price 954 Favorable (Unfavorable) Direct labor budget variance: Budget for direct labor cost Actual direct labor cost Favorable (Unfavorable) Direct labor volume variance: Actual volume @ standard rate Standard volume @ standard rate Favorable (Unfavorable) $35 $34.95 Total $35,000 34,950 $50 $35 $35 33,250 33,390 ($140) 1,000 $6 $6,000 6,120 ($120) 950 1,000 $6 $6 $5,700 6,000 ($300) Double-check computations for total piston shaft variances: Standard cost for quantity of pistons produced (950*$35) $33,250 Actual cost for piston shafts purchased $(34,950) Increase in cost of raw material inventory: Quantity purchased 1,000 Quantity used 954 Increase in inventory quantity 46 Standard cost per piston shaft $ 35 Book value of raw material inventory increase 1,610 Actual cost of pistons used in production (33,340) Total piston shaft variance $ (90) U Sum of price and efficiency variances [$50 + $(140)] $ (90) U Double-check computations for direct labor variances: Standard cost for quantity of pistons produced (950*$6) Actual direct labor cost Total direct labor variance $ 5,700 (6,120) $ (420) U Sum of direct labor budget and volume variances [$(120)+$(300)] $ (420) U To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 11-30 Cost Management C FACTORY OVERHEAD COST VARIANCES Quantity Variable overhead spending variance: Actual DL hours @ standard cost 397 Actual variable overhead cost Favorable (Unfavorable) Variable overhead efficiency variance: Standard variable overhead cost Standard variable overhead based on actual direct labor hours Favorable (Unfavorable) Fixed overhead budget variance: Budget for fixed overhead Actual fixed overhead Favorable (Unfavorable) Fixed overhead volume variance: Actual volume @ standard rate Standard volume @ standard rate Favorable (Unfavorable) Standard Total $10 $3,970 3,677 $293 380 $10 $3,800 397 $10 1,000 $20 $20,000 18,325 $1,675 950 1,000 $20 $20 $19,000 20,000 ($1,000) 3,970 ($170) Double-check computations for variable overhead variances: Standard cost for quantity of pistons produced (950*$4) Actual variable overhead cost Total variable overhead variance $ $ 3,800 (3,677) 123 F Sum of spending and efficiency variances [$293+$(170)] $ 123 F Double-check computations for fixed overhead variances: Standard cost for quantity of pistons produced (950*$20) Actual fixed overhead cost Total fixed overhead variance $ $ 19,000 (18,325) 675 F Sum of budget and volume variances [$1,675+$(1,000)] $ 675 F D Below is an excerpt from a sample spreadsheet showing the total selling and administrative variance for this problem SELLING AND ADMINISTRATIVE VARIANCE Quantity Standard selling and administrative costs: Fixed Variable 950 Total standard cost Actual cost Favorable (Unfavorable) Standard $10 Total $50,000 9,500 59,500 59,101 $399 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11: Standard Costs and Variance Analysis 11-31 E Before preparing a report that would be useful in evaluating control of production costs, identify costs that are relevant to production: direct costs and factory overhead The selling and administrative costs are not relevant Next, identify the relevant variances for evaluating production costs: the price and efficiency variances for direct materials, the spending variance for direct labor (because it is a fixed cost) and variable overhead, and the budget variance for fixed overhead costs The variable overhead efficiency variance is not relevant because its information is already provided by the direct labor efficiency variance The direct labor and production volume variances are not relevant because total volume is assumed to be driven by sales rather than by the production department Below is an excerpt from a sample spreadsheet showing a production cost variance report for this problem PRODUCTION COST VARIANCE REPORT Static Budget Piston shafts $35,000 Shaft housings 20,000 Direct labor 6,000 Variable factory overhead 4,000 Fixed factory overhead 20,000 Total production costs $85,000 Flexible Budget $33,250 19,000 6,000 3,970 20,000 $82,220 Actual Cost $33,340 19,000 6,120 3,677 18,325 $80,462 Variance Price/ Efficiency/ Spending Volume $50 ($140) 0 (120) 293 1,675 $1,898 ($140) Net amount of relevant production cost variances $1,758 The actual cost for piston shafts was calculated in Part B F The production cost variances would be closed using the method shown on pages 437438 in the textbook The first step is to sum all of the production cost variances and determine whether they are material Below is an excerpt from a sample spreadsheet computing the net amount of all production cost variances SUMMARY OF PRODUCTION COST VARIANCES Standard Cost Piston shafts $33,250 Shaft housings 19,000 Direct labor 5,700 Variable factory overhead 3,800 Fixed factory overhead 19,000 Total production costs $80,750 Actual Cost $33,340 19,000 6,120 3,677 18,325 $80,462 Proof of calculations: Net amount of relevant production cost variances Variances not used in evaluating production cost performance: Direct labor volume variance Variable factory overhead efficiency variance Fixed factory overhead volume variance Net amount of all production cost variances Total Variance ($90) (420) 123 675 $288 $1,758 (300) (170) (1,000) $288 The second step is to compare the total net amount of production cost variances ($288 F) with total actual production costs ($80,462) In this case, the variances amount to only To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 11-32 Cost Management 0.4% of actual costs Therefore, the variances would be considered immaterial, and the adjustment would be made entirely to cost of goods sold The adjusting journal entry would be made as follows: Piston shafts direct materials price variance Variable overhead spending variance Fixed overhead budget variance Piston shafts direct materials efficiency variance Direct labor spending variance Direct labor volume variance Variable overhead efficiency variance Production volume variance Cost of goods sold 50 293 1,675 140 120 300 170 1,000 288 G As manager of the piston division, I would like to know if the quality of the pistons was the same as usual Four more pistons were used than expected, so it is possible that quality has been compromised with a lower price This could be a problem if defective shafts are not removed from production and customers receive more defective pistons than usual Sales volumes could drop I would also like to know why labor costs and hours were up If workers had to work overtime because of a quality problem, cost and hours would be up It appears that fixed and variable overhead costs were under control, and were even less than expected during the period Because the fixed overhead budget variance is fairly large, I would want to know if something has changed and whether the use of overhead has improved If so, the standard could be changed, although the efforts of workers to reduce fixed costs needs to be recognized and praised 11.33 Bramlett Company A The problem states that management wants to maintain the selling price for several years, so the assumption is made that long-run standard costs will be used for pricing, rather than the expected costs during start up Standard cost per unit Direct materials Direct labor Variable overhead Fixed overhead (a) Total Markup Selling price pieces @ $20 10 hours @ $25 50% x $250 42.666% x $250 60% x $562 $ 80 250 125 107 562 337 $899 (a) After start up, the firm will produce 1,500 units per month, or 18,000 per year The budgeted labor costs for 18,000 units is 18,000 x $250 = $4,500,000 Using the same basis to allocate fixed overhead as is used to allocate variable overhead yields a fixed overhead rate of $1,920,000/$4,500,000 = 42.666% of labor cost To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11: Standard Costs and Variance Analysis 11-33 B The variances for product costing purposes using the long-term standards would be Labor price variance (Standard price – actual price) x actual hours = ($25 - $26) x 12,000 = $12,000 U Labor efficiency variance (Standard quantity for actual output – actual quantity) x standard price =[(10 x 950) - 12,000] x $25 = $62,500 U For product costing purposes, the overhead variances would be as follows (note that overhead is based on labor cost, not hours): Variable overhead spending variance = Actual allocation base (labor cost) at standard rate – actual variable overhead = [(50% x $312,000) - $160,250 = $ 4,250 U Fixed overhead budget variance Static budget for fixed costs (budgeted fixed overhead per month) – actual fixed overhead = [($1,920,000/12 - $172,220] = $160,000 - $172,220 = $ 12,220 U Variable overhead efficiency variance = Standard allocation base at standard rate – actual allocation base at standard rate = (Standard labor cost – actual labor cost) x standard variable rate = [($25 x 10 hours x 950 units) - $312,000] x 50% = $37,250 U Production volume variance = Standard allocation base at standard rate (allocated cost) – estimated allocation base at standard rate (static budget) = (Standard labor cost for actual output – standard labor cost for estimated output) x standard rate = [($25 x 10 hours) x (950 units - 1,500)] x 0.42666 = ($237,500 - $375,000) x 0.42666 = $58,666 U C Here are some pros and cons for using the long-term standard for the first month’s operations Pros: The accounting department performs the calculations they will use for the next year, and personnel will gain experience with the new system The variances will reflect the results of the long-term standard and give workers a more accurate picture of the gaps in their performance Using the long-term standard may highlight areas with very large variances that are likely to have larger variances over the next few months To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 11-34 Cost Management Cons: Workers may be discouraged when their performance is compared to such high standards The standard will not be viewed as realistic, and so may be ignored causing poorer performance in the first few months than otherwise Information about variances from these standards is of poor quality and cannot be used reliably for planning or monitoring D The short term standards not affect the labor price variance It remains the same as above: Labor price variance =(Standard price – actual price) x actual hours = ($25 - $26) x 12,000 = $12,000 U However, a substantial portion of the labor efficiency variance was anticipated That is, management expected it to take 10 x 1.2 = 12 hours per unit during the first month of operations The following variance better reflects performance Labor efficiency variance = [(12 x 950) - 12,000] x $25 = $15,000 U The overhead spending and budget variances are probably unaffected by the learning curve experienced by labor Therefore, they are the same as in part B, as follows Variable spending variance = Actual allocation base (labor cost) at standard rate – actual variable overhead = [(0.5 x $312,000) - $160,250 = $ 4,250 U Fixed overhead budget variance = Static budget fixed costs (budgeted fixed overhead per month) – actual fixed overhead = [($1,920,000/12 - $172,220] = $160,000 - $172,220 = $ 12,220 U The following variances are used as adjusting entries in the accounting records It may be more appropriate for these variances to reflect the expected short-term performance as well Therefore they could be calculated as follows Variable overhead efficiency variance = [($25 x 12 x 950) - $312,000] x 0.5 = $13,500 U Production volume variance = [($25 x 12 x 950) - ($25 x 12 x 1,000)] x 0.5333 = ($285,000 - $300,000) x 0.5333 = 8,000 U To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11: Standard Costs and Variance Analysis 11-35 Where the adjusted fixed overhead rate is calculated as: Monthly fixed overhead = $1,920,000/12 = $ 160,000 Anticipated labor costs = ($25 x 12 x 1,000) = $300,000 Rate based on anticipated activity = $160,000/$300,000 = 53.33% E Following are several possible reasons for the variances Students may think of others Direct labor price variance: Because labor used more hours, overtime may have been paid In addition, it is possible that workers with higher skill levels were hired It is also possible that the standard is too low, that labor rates increased during the month Direct labor efficiency variance: The standard may be wrong because workers have so little experience at this new plant, the company may still be experiencing a learning curve, or labor may be working inefficiently for some reason such as lack of training, high absenteeism, or just low productivity Variable overhead spending variance: Because this was the first month, it is possible that some costs were higher than anticipated For example, the company may expect to receive volume discounts on indirect materials, but does not earn them until order sizes become as large as anticipated Indirect labor may have had to work extra hours and received overtime pay There may have been more maintenance on machines than anticipated during the start-up period Fixed overhead budget variance It is possible that utilities were higher than anticipated due to season or weather-related factors The standard may be too low because accountants did not anticipate all of the fixed costs Some periodic costs such as taxes or insurance may have been paid this month F Managers respond to variances according to the results of their investigations If they find the standard is wrong, they change the standard For example, it is likely that some of the standards at Bramlett will need adjusting as the company obtains more experience with the new product If managers find that operations are out of control, they will monitor operations more closely and ask employees for suggestions to improve performance If managers realize that the variances for this month are based on longterm standards, they may nothing because they believe that over the next few months the variances will disappear If managers discover that labor variances are related to employee turnover or absence, they may use compensation incentives based on attendance or longevity to improve this aspect of operations However, increasing compensation will also increase labor costs, so the costs and benefits of these types of alternatives need to be analyzed Students may have thought of a number of different ways that managers respond to the variance information G Because uncertainties exist about the appropriate amount for standards, it would probably be more difficult to analyze the variances at the new plant It will take a number of months before production at the new plant becomes stable At that time it will be easier to set standards because accountants will know more about regular operations, and most of the learning will have taken place, so results are less likely to be affected by learning curves To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 11-36 Cost Management BUILD YOUR PROFESSIONAL COMPETENCIES 11.34 Focus on Professional Competency: Interaction A An accountant’s role in developing standards, analyzing variances, and recommending actions varies from organization to organization, depending on the nature of the business and the organizational structure In some organizations, engineers or quality control personnel handle these activities In other organizations, accountants gather information, perform calculations, and develop forecasts that are used in creating standards They also gather information about large or important variances, analyze their causes, and then recommend appropriate actions Accountants must work with others in the organization to perform the tasks described in Part A.1 above For example, they gather information from people who work in the operating areas for which standards are developed as well as from other personnel in areas such as engineering, human resources, and purchasing Ideally, they work as partners with managers in various departments to help them develop reasonable standards and improve operations over time B Attainable standards are standards that should be achievable by employees, given existing or planned operating processes Slack is an allowance built into standards to permit deviation from “perfect” performance Standards are more likely to be attainable if they contain some slack to allow normal variation in cost and efficiency However, standards having too much slack fail to motivate employees to achieve better results Managers cannot know for certain whether standards are reasonable because it is difficult or impossible to measure the level of achievable performance Information about past performance and measures built on that performance could include slack Studies of performance are sometimes unreliable because employees may perform poorly knowing that a standard will be developed based on their performance Also, higher levels of performance may be achievable for short time periods, but might not be sustainable over long time periods Different students will provide different examples from their own experiences Team protocols and expectations are sometimes communicated explicitly, but they may also be implicit New members to a team often learn about protocols by asking questions and by observing team behavior Production employee incentives are similar to the incentives discussed in Part B.1 for all employees Standards can motivate employees to work harder and more efficiently to achieve explicit goals However, employees are more likely to work toward standards they perceive as achievable When standards are too difficult to achieve, employees may give up and not attempt to meet them To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 11: Standard Costs and Variance Analysis 11-37 C Some people believe that cooperation means giving in to others Instead, true cooperation involves listening carefully to others’ perspectives, attending to diverse interests, and working together to reach the best overall result Thus, cooperation should encourage free expression rather than discourage it Each student will have his or her own experiences to share when answering this question The purpose is to help students reflect on what constitutes useful coaching/mentoring 11.35 Integrating Across the Curriculum: Auditing A There are many possible errors that could cause a variance even when no variance actually exists Below are possible answers to this question; students may think of others Direct materials price: The company has a policy of using the net method for recording early payment discounts, but an accountant erroneously recorded the purchase transaction using the gross method Then when payment was made, a credit was erroneously recorded to a miscellaneous income account instead of to the cost of direct material purchases This combination of errors would cause the cost of direct materials purchased to be overstated Direct materials efficiency: A mechanical error could have occurred in recording the quantity of direct materials used in production For example, a clerk might have accidentally entered a quantity of “975” instead of “957,” overstating the quantity of direct materials used Direct labor price: A payroll department employee made an error when entering the pay rate for an individual production employee in the payroll system This error would cause the employee to be overpaid or underpaid, which in turn would overstate or understate direct labor cost Direct labor efficiency: A production employee accidentally miscoded her time, causing hours to be charged to direct labor instead of indirect labor This error would overstate direct labor hours and understate indirect labor hours (in either variable or fixed overhead cost) Variable overhead spending: When making an entry to record the transfer of indirect materials from the warehouse to production, a clerk accidentally coded the materials as direct materials instead of indirect materials This error would overstate direct material costs and understate variable overhead costs Variable overhead efficiency: An error in the accuracy of the variable overhead cost allocation base would also cause an error in this variance For example, if the cost allocation base is either direct labor hours or direct labor costs, then the errors described above for direct labor efficiency or direct labor spending would cause an error in the variable overhead efficiency variance To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 11-38 Cost Management Fixed overhead budget: An accounting clerk might have accidentally coded a fixed overhead cost as a variable overhead cost This error would cause fixed overhead costs to be overstated and variable overhead costs to be understated Production volume: An error in the computation of units produced would cause an error in this variance Suppose personnel forget to record the number of units spoiled during a particular production run This error would cause the number of good units produced to be too high, overstating the production volume B The theft of inventory is accounted for with any other errors in inventory quantities at the time physical inventory is counted Because it is not possible to distinguish between theft and errors, the adjustment for missing raw materials inventory is usually recorded as either direct materials or indirect materials (most likely in variable overhead) If the adjustment is recorded to direct materials, then the theft would be reflected in the direct materials efficiency variance (the usage of raw materials would appear to be higher) If the adjustment is recorded to indirect materials, then the theft would overstate variable overhead costs, which would be reflected in the variable overhead spending variance C There are several reasons for failing to uncover theft through analysis of the affected variances Variances include offsetting positive and negative items, and the theft might be offset by positive variances such as more efficient use of materials In addition, cost standards are often set based on past experience If the company has always experienced significant theft, then the cost would already be anticipated in the cost standards D Assuming that the fictitious employee time is charged to direct labor, this fraud would be reflected in the direct labor efficiency variance If the pay rate for the fictitious employee is not equal to the standard direct labor pay rate, then the fraud would also be reflected in the direct labor price variance If time for the fictitious employee is charged to an overhead account, then this fraud would be reflected in the variable overhead spending variance or fixed overhead budget variance E This error will cause variable overhead costs to be overstated this year by the difference between the total cost and the amount that should have been depreciated this year Variable overhead costs will be understated in future years by the amount of depreciation that should have been recorded This error would be reflected in the variable overhead spending variance During the current year the variance would be less favorable (or more unfavorable), and in future years it would be more favorable (or less unfavorable) F The most obvious way to increase earnings by misapplying accounting principles for variances is to close material variance accounts incorrectly For example, favorable variances could be closed to cost of goods sold instead of prorated to cost of goods sold and work in process ... ebook, solutions and test bank, visit http://downloadslide.blogspot.com 11-14 Cost Management C Standard units sold at standard sales mix and standard CM $225,000 Actual units sold at standard... difference between standard and actual fixed costs: Standard fixed costs – Actual fixed costs = $60,000 - $58,720 = $1,280 Favorable To download more slides, ebook, solutions and test bank, visit... actual quantity sold and the standard quantity, given the standard sales mix and standard contribution margin The average contribution margin at standard sales mix and standard contribution margin