Performance Evaluation Using Variances From Standard Costs

Chapter 22 Performance Evaluation Using Variances from Standard Costs Accounting, 21st Edition Warren Reeve Fess

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Objectives Objectives 1. Describe the types of standards and how After this After studying studying this they are established for businesses. should chapter, you should 2. Explain andchapter, illustrateyou how standards are be used in budgeting. be able able to: to: 3. Calculate and interpret direct materials price and quantity variances. 4. Calculate and interpret direct labor rate and time variances.

Objectives Objectives 5. Calculate and interpret factory overhead controllable and volume variances.

6. Journalize the entries for recording standards in the accounts and prepare an income statement that includes variances from standards. 7. Explain how standards may be used for nonmanufacturing expenses. 8. Explain and provide examples of nonfinancial performance measures.

Standards—Performance Standards—Performance Benchmarks Benchmarks Setting Standards Requires joint efforts of accountants, engineers, and other management personnel

Types of Standards Theoretical or ideal (world record) standards Currently attainable standards (normal standards)

Reviewing and Revising Standards Should be revised when they no longer reflect operating conditions they intended to measure

Western Rider Inc., a manufacturer of blue jeans, uses standard manufacturing costs in its budgets.

Western Rider Inc. Standard Cost per Pair of XL Jeans

Direct materials: $5.00 per square yard x 1.5 square yards = $ 7.50 Direct labor: $9.00 per hour x 0.80 hour per pair = 7.20 Factory overhead: $6.00 per hour x 0.80 hour per pair = 4.80 Total standard cost per pair $19.50

Western Rider Inc. Budget Performance Report For the Month Ended June 30, 2006

Manufacturing Costs

Actual Costs

Direct materials $ 40,150 Direct labor 38,500 Factory overhead 22,400 Total mfg. costs $101,050

Standard Cost Cost at Actual Variance Volume (favorable) (5,000 units) Unfavorable 5,000 5,000 xx

$37,500 36,000 24,000 $97,500

$2,650 $7.50 $7.50 per per pair 2,500 pair (1,600) $3,550

Direct Direct Materials Materials Cost CostVariance Variance

Total Total Manufacturing Manufacturing Cost CostVariance Variance

Direct Direct Labor Labor Cost CostVariance Variance

Factory Factory Overhead Overhead Cost CostVariance Variance

Direct DirectMaterials MaterialsPrice Price Variance Variance Direct DirectMaterials MaterialsPrice Price Variance Variance Direct DirectLabor LaborRate Rate Variance Variance Direct DirectLabor LaborTime Time Variance Variance Variable VariableFactory FactoryOverhead Overhead Controllable ControllableVariance Variance Fixed FixedFactory FactoryOverhead Overhead Volume VolumeVariance Variance

Direct Direct Materials Materials Price Price Variance Variance Actual price per unit Standard price per unit Price variance (unfavorable)

$5.50 per sq. yd. 5.00 per sq. yd. $0.50 per sq. yd.

$0.50 times the actual quantity of 7,300 sq. yds. = $3,650 unfavorable

Direct Direct Materials Materials Quantity Quantity Variance Variance Actual quantity used 7,300 sq. yds. Standard quantity at actual production 7,500 Quantity variance (favorable) (200) sq. yds. (200) square yards times the standard price of $5.00 = ($1,000) favorable

Direct Direct Materials Materials Variance Variance Relationships Relationships Actual quantity x Actual price 7,300 x $5.50 = $40,150

Actual quantity x Standard price 7,300 x $5.00 = $36,500

Standard quantity x Standard price 7,500 x $5.00 = $37,500

Material Price Variance

Material Quantity Variance

$3,650 U

($1,000) F

Direct Direct Materials Materials Variance Variance Relationships Relationships Actual quantity x Actual price 7,300 x $5.50 = $40,150

Actual quantity x Standard price 7,300 x $5.00 = $36,500

Standard quantity x Standard price 7,500 x $5.00 = $37,500

Total Direct Materials Cost Variance $2,650 U

Direct Direct Labor Labor Variances Variances Standard direct labor hours per of XL jeans 0.80 direct labor hour Actual units produced x 5,000 pairs of jeans Standard direct labor hours budgeted for actual production 4,000 direct labor hours Standard rate per DLH x $9.00 Standard direct labor cost at actual production $36,000

Direct Direct Labor Labor Variances Variances Actual direct labor hours used in production 3,850 direct labor hours Actual rate per direct labor hour x $10.00 Total actual direct labor cost $ 38,500

Direct Direct Labor Labor Rate Rate Variance Variance Actual rate $10.00 Standard rate 9.00 Rate variance (unfavorable) $1.00 per DLH $1.00 times the actual time of 3,850 hours = $3,850 unfavorable

Direct Direct Labor Labor Time Time Variance Variance Actual hours Standard hours at actual production Time variance

3,850 DLH 4,000 (150) DLH

(150) Direct labor hours times the standard rate of $9.00 = ($1,350) favorable

Direct Direct Labor Labor Variance Variance Relationships Relationships Actual hours x Actual rate 3,850 x $10 = $38,500

Actual hours x Standard rate 3,850 x $9.00 = $34,650

Standard hours x Standard rate 4,000 x $9.00 = $36,000

Direct Labor Rate Variance

Direct Labor Time Variance

$3,850 U

($1,350) F

Direct Direct Labor Labor Variance Variance Relationships Relationships Actual hours x Actual rate 3,850 x $10 = $38,500

Actual hours x Standard rate 3,850 x $9.00 = $34,650

Standard hours x Standard rate 4,000 x $9.00 = $36,000

Total Direct Labor Cost Variance $2,500 U

Overhead is applied at $6.00 per direct labor hour based on estimated 5,000 total hours.

Variances from standard for factory overhead result from: 1. Actual variable factory overhead cost greater or less than budgeted variable factory overhead for actual production. 2. Actual production at a level above or below 100% of normal capacity.

Western Rider Inc. produced 5,000 pairs of XL jeans in June. Each pair requires 0.80 standard labor hours for production. The firm operated at 80% of capacity. Direct Labor Hours 4,000 5,000 5,500

Percentage of capacity

80%

100%

110%

Total variable costs Actual variable overhead Variable overhead variance—favorable

$14,400 10,400

$18,000

$19,800

$(4,000) F

Level of activity

Controllable Controllable variance variance based based on on variable variable costs costs

Western Rider Inc. produced 5,000 pairs of XL jeans in June. Each pair requires 0.80 standard labor hours for production. The firm operated at 80% of capacity. Direct Labor Hours 4,000 5,000 5,500

Percentage of capacity Total fixed costs Fixed cost per DLH

80% 12,000 $3.00

100% 12,000 $2.40

Desired Standard hours capacity at actual production

110% 12,000 $2.18

Western Rider Inc. produced 5,000 pairs of XL jeans in June. Each pair requires 0.80 standard labor hours for production. The firm operated at 80% of capacity. Direct Labor Hours 4,000 5,000 5,500

Percentage of capacity Total fixed costs Fixed cost per DLH

80% 12,000 $3.00

100% of normal capacity Standard hours at actual production Capacity not used Standard fixed overhead rate at 100% Fixed overhead volume variance

100% 12,000 $2.40

110% 12,000 $2.18

5,000 4,000 1,000 x $2.40 $ 2,400

DLH DLH DLH U

Western Rider Inc. Factory Overhead Cost Variance Report For the Month Ended June 30, 2006 Productive capacity for the month (100% of normal) 5,000 hours Actual production for the month 4,000 hours Budget (at Actual Production)

Unfavorable

Actual

Variable factory overhead costs $14,400 $10,400 Fixed factory overhead costs 12,000 12,000 Total factory overhead costs $26,400 $22,400 Total controllable variances Net controllable variances— favorable Volume variance—unfavorable: Capacity not used at the standard rate for fixed factory overhead—1,000 x $2.40 Total factory overhead cost variance--favorable

Variances Favorable

$4,000

$4,000

$

0

$4,000

2,400 $1,600

Fixed Fixed Overhead Overhead Variances Variances and and the the Factory Factory Overhead Overhead Account Account Factory Overhead Actual factory overhead

Applied factory $22,400 overhead Balance, June 30 $10,400 $10,400 ++ $12,000 $12,000

$24,000 1,600

4,000 4,000 hours hours xx $6.00 $6.00 per per hour hour

Fixed Fixed Overhead Overhead Variances Variances and and the the Factory Factory Overhead Overhead Account Account Factory Overhead Actual factory overhead

Applied factory $22,400 overhead Balance, June 30

Controllable Variance:

$4,000 F $22,400 $22,400 –– $26,400 $26,400

$24,000 1,600

Fixed Fixed Overhead Overhead Variances Variances and and the the Factory Factory Overhead Overhead Account Account Factory Overhead Actual factory overhead

Applied factory $22,400 overhead

$24,000

Balance, June 30 Volume Variance:

$2,400 U $26,400 $26,400 –– $24,000 $24,000

1,600

Fixed Fixed Overhead Overhead Variances Variances and and the the Factory Factory Overhead Overhead Account Account Total Factory Overhead Variance Controllable variance Volume variance Total

$4,000 F 2,400 U $1,600 F

Fixed Fixed Overhead Overhead Variances Variances and and the the Factory Factory Overhead Overhead Account Account Budgeted Factory Overhead for Amount Produced

Controllable variance Fixed factory overhead Total

$14,400 12,000 $26,400

Recording and Reporting Variances from Standards

On On August August 1, 1, Western Western Rider Rider Inc. Inc. purchased, purchased, on on account, account, the the 7,300 7,300 square square yards yards of of blue blue denim denim at at $5.50 $5.50 per per square square yard. yard. Recall, Recall, the the standard standard price price was was $5.00. $5.00. Aug. 1 Materials (7,300 sq. yds. X $5.00) Direct Materials Price Variance Accounts Payable

$5.50 $5.00

x x

7,300 7,300

36 500 00 3 650 00 40 150 00

$3,650 U = $40,150 Direct = $36,500 materials price variance

Western Western Rider Rider Inc. Inc. used used 7,300 7,300 square square yards yards of of blue blue denim denim to to produce produce 5,000 5,000 pairs pairs of of XL XL jeans, jeans, compared compared to to the the standard standard of of 7,500 7,500 square square yards. yards. Date Date the the entry entry August August 31. 31. Aug. 31 Work in Process (7,500 x $5.00)

37 500 00

Direct Materials Quantity Variance Materials (7,300 x $5.00)

Standard quantity $5.00price x Actual7,300 Standard price x Standard $5.00 7,500 quantity

1 000 00 36 500 00

$1,000 F = $36,500 Direct = $37,500 Materials quantity variance

For For the the month month of of August, August, Western Western Rider Rider Inc. Inc. accrued accrued wages wages of of $38,500 $38,500 (3,850 (3,850 hours hours at at $10 $10 per per hour) hour) in in producing producing 5,000 5,000 XL XL Jeans. Jeans. The The standard standard rate rate isis $9 $9 per per hour hour and and each each pair pair of of jeans jeans had had aa time time standard standard of of 0.8 0.8 hr. hr. Aug. 31 000 00 Direct Labor Rate Variance Direct Labor Time Variance Wages Payable

Work in Process

36

3 850 00

1 350 00 38 500 00

$10.00 Actual rate x Actual3,850 hours = $38,500 $3,850 U (rate) Standard hours $9.00rate x Actual3,850 = $34,650 $1,350 F (time) Standard quantity = $36,000 $9.00rate x Standard 4,000

This entry is not shown in the textbook.

Western Rider Inc. Income Statement For the Month Ended June 30, 2006

Sales…………………………………… Cost of goods sold…………………….. Gross profit--at standard……………….

$140,000 97,500 $ 42,500

Favorable Unfavorable

Less variances from standard cost: Direct materials price……………….. Direct materials quantity……………. $1,000 Direct labor rate…………………….. Direct labor time……………………. 1,350 Factory overhead controllable………. 4,000 Factory overhead volume…………… Gross profit……………………………. Operating expenses……………………. Income before income tax……………..

$3,650 3,850 2,400

3,550 $38,950 25,725 $13,225

Nonfinancial Performance Measures  Inventory turnover  On-time delivery  Elapsed time between a customer order and product delivery  Customer preference rankings compared to competitors  Response time to a service call  Time to develop new products  Employee satisfaction  Number of customer complaints

Nonfinancial Performance Measures (Fast Food Restaurant) Inputs Inputs Employee Employeetraining training Employee Employeeexperience experience Number Numberof ofnew newmenu menu items items Number Numberof ofemployees employees Fryer Fryerreliability reliability Fountain Fountainsupply supply availability availability

Activity Counter service

Outputs Outputs Line Linewait wait Percent Percentorder order accuracy accuracy Friendly Friendlyservice service score score

Chapter 22 The The End End