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23

Performance Evaluation Using Variances From Standard Costs


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After studying this chapter, you should be able to:

  • Describe the types of standards and how they are established for businesses.

  • Explain and illustrate how standards are used in budgeting.

  • Compute and interpret direct materials and direct labor variances.


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After studying this chapter, you should be able to:

  • Compute and interpret factory overhead controllable and volume variances.

  • Journalize the entries for recording standards in the accounts and prepare an income statement that includes variances from standard.


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After studying this chapter, you should be able to:

  • Explain and provide examples of nonfinancial performance measures.


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23-1

Objective 1

Describe the types of standards and how they are established for businesses.


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23-1

Standards

Standards are performance goals. Manufacturers normally use standard costs for each of the three manufacturing costs:

  • Direct materials

  • Direct labor

  • Factory overhead


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23-1

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


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23-1

When actual costs are compared with standard costs, only the exceptions or variances are reported for cost control (called reporting by the principle of exceptions).


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

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23-1

Setting Standards


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23-1

Types of Standards

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


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23-1

Currently attainable standardsor normal standardscan beattained with reasonable effort. Standards set at this level allow for disruptions, such as material spoilage and machine breakdowns.


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23-1

Reviewing and Revising Standards

Standard costs should be continuously reviewed and should be revised when they no longer reflect operating conditions.


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23-1

Critics of Using Standards

Critics of standards believe the following:

  • Standards limit operating improvements by discouraging improvements beyond the standard.

  • Standards are too difficult to maintain in a dynamic manufacturing environment, resulting in “stale standards.”

(Continued)


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23-1

Critics of Using Standards

  • Standards can cause workers to lose sight of the larger objectives of the organization by focusing only on efficiency improvements.

  • Standards can cause workers to unduly focus upon their own operations to the possible harm of other operations that rely on them.


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23-2

Objective 2

Explain and illustrate how standards are used in budgeting.


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23-2

Standard Cost for XL Jeans

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23-2

Budget Performance Report

The budget performance report summarizes the actual costs, the standard amounts for the actual level of production achieved, and the differences between the two amounts (called cost variances).


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23-2

A favorablecost variance occurs when the actual cost is less than the standard cost (at actual volumes).

An unfavorablecost variance occurs when the actual cost exceeds the standard cost (at actual volumes).


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23-2

Budget Performance Report

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23-2

Relationship of Variances to the Total Manufacturing Cost Variances

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23-3

Objective 3

Compute and interpret direct materials and direct labor variances.


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23-3

Direct Materials

Standard square yards per pair of jeans1.50sq. yards

Actual units producedx 5,000pairs of jeans

Standard square yards of denim budgeted foractual production7,500sq. yards

Standard price per sq. yd.x $5.00

Standard direct materials costat actual production$37,500

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23-3

Direct Materials Price Variance

Actual price per unit$5.50per sq. yd.

Standard price per unit 5.00 per sq. yd.

Price variance (unfavorable)$0.50per sq. yd.

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

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23-3

Direct Materials Quantity Variance

Actual quantity used7,300 sq. yds.

Standard quantity at

actual production7,500

Quantity variance (favorable) (200) sq. yds.

(200) square yards x the standard price of $5.00 = ($1,000) favorable

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23-3

Direct Materials Variance Relationships

Actual cost:

Standard cost:

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

Actual quantity x Actual price 7,300 x $5.50 = $40,150

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

Materials price variance

Material quantity variance

$3,650 U

($1,000) F

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(Continued)


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

Actual quantity x Actual price 7,300 x $5.50 = $40,150

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

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23-3

Direct Materials Variance Relationships

Actual cost:

Standard cost:

Total direct materials cost variance

$2,650 U

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(Concluded)


Example Exercise 23-1

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23-3

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

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Follow My Example 23-1

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23-3

  • Direct materials price variance (favorable)

  • ($2,775) [($4.35 – $4.50) x 18,500 pounds]

  • Direct materials quantity variance (unfavorable)

  • $2,250 [(18,500 pounds – 18,000 pounds) x

  • $4.50]

  • Direct materials cost variance (favorable)

  • ($525) [($2,775) + $2,250] or[($4.35 x 18,500 pounds) – ($4.50 x 18,000 pounds)] = $80,475 – $81,000

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For Practice: PE23-1A, PE23-1B


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23-3

Direct Labor Variances

Standard direct labor hours per pair of XL jeans0.80direct labor hour

Actual units producedx 5,000pairs of jeans

Standard direct labor hours budgeted for actualproduction4,000direct labor hours

Standard rate per DLHx $9.00

Standard direct labor cost at actual production$36,000

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23-3

Direct Labor Rate Variance

Actual rate$10.00

Standard rate 9.00

Rate variance—unfavorable$ 1.00per hour

$1.00 x the actual time of 3,850 hours =$3,850 unfavorable

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23-3

Direct Labor Time Variance

Actual hours3,850DLH

Standard hours at actualproduction 4,000

Time variance—favorable(150)DLH

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

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23-3

Direct Labor Variance Relationships

Actual cost:

Standard cost:

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

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(Continued)


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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

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23-3

Direct Labor Variance Relationships

Actual cost:

Standard cost:

Total direct labor cost variance

$2,500 U

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(Concluded)


Example Exercise 23-2

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23-3

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

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Follow My Example 23-2

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23-3

  • Direct labor rate variance (unfavorable)

  • $2,226 [($12.30 – $12.00) x 7,420 hours]

  • Direct labor time variance (favorable)

  • ($960) [7,420 hours – 7,500 hours) x $12.00]

  • Direct labor cost variance (unfavorable)

  • ($1,266) [$2,226 + ($960)] or [($12.30 x 7,420 hours) – ($12.00 x 7,500 hours)] = $91,266 – $90,000

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For Practice: PE23-2A, PE23-2B


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23-4

Objective 4

Compute and interpret factory overhead controllable and volume variances.


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23-4

Factory overhead costs are more difficult to manage than are direct labor and materials costs because the relationship between production volume and indirect costs is not easy to determine.


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23-4

Factory Overhead Cost Budget Indicating Standard Factory Overhead Rate

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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.

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Variances from standard for factory overhead cost result from:

23-4

The Factory Overhead Flexible Budget


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23-4

Variable Factory Overhead Controllable Variance

Actual variable factory overhead$ 10,400

Budgeted variable factory overheadfor actual amount produced (4,000 hrs. x $3.60) 14,400

Controllable variance— favorable$ (4,000) F

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Example Exercise 23-3

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23-4

Tip Top Corp. produced 3,000 units of product that required 2.5 standard hours per unit. The standard variable overhead cost per unit is $2.20 per hour. The actual variable factory overhead was $16,850. Determine the variable factory overhead controllable variance.

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Follow My Example 23-3

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23-4

$350 unfavorable

$16,850 – [$2.20 x (3,000 units x 2.5 hours)]

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For Practice: PE23-3A, PE23-3B


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23-4

Fixed Factory Overhead Volume Variance

100% of normal capacity5,000direct labor hours

Standard hours at actual production 4,000

Capacity not used1,000direct labor hours

Standard fixed overhead ratex $2.40

Volume variance—unfavorable$ 2,400U

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23-4

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Example Exercise 23-4

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23-4

Tip Top Corp. produced 3,000 units of product that required 2.5 standard hours per unit. The standard fixed overhead cost per unit is $0.90 per hour at 8,000 hours, which is 100% of normal capacity. Determine the fixed factory overhead volume variance.

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Follow My Example 23-4

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23-4

$450 unfavorable

$0.90 x [8,000 hours – (3,000 units x 2.5 hours)]

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For Practice: PE23-4A, PE23-4B


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23-4

Reporting Factory Overhead Variances

Total actual factory overhead$22,400

Factory overhead applied (4,000hours x $6.00 per hour) 24,000

Total factory overhead cost variance—favorable$(1,600)F

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23-4

Factory Overhead Cost VarianceReport

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4,000 hours x $6.00 per hour

$10,400 + $12,000

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23-4

Factory Overhead Variances and the Factory Overhead Account

Factory Overhead

Actual factory overhead22,400

Applied factory overhead24,000

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Factory Overhead

Actual factory overhead22,400

Applied factory overhead24,000

Balance, June 301,600

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23-4

Overapplied factory overhead

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Factory Overhead

Actual factory OH22,400

Applied factory OH24,000

Budgeted Factory Overhead for Amount Produced

Variable factory OH$14,400

Fixed factory OH 12,000

Total$26,400

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23-4

Applied Factory Overhead

$24,000

Actual Factory Overhead

$22,400

Volume Variance

Controllable Variance

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$(4,000) F

$2,400 U

(Continued)


Factory Overhead

Actual factory OH22,400

Applied factory OH24,000

Budgeted Factory Overhead for Amount Produced

Actual Factory Overhead

$22,400

Variable factory OH$14,000

Fixed factory OH 12,000

Total$26,400

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23-4

Applied Factory Overhead

$24,000

$(1,600) F

Total Factory Overhead Cost Variance

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(Concluded)


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23-5

Objective 5

Journalize the entries for recording standards in the accounts and prepare an income statement that includes variances from standard.


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23-5

Standard costs can be used solely as a management tool separate from the accounts in the general ledger. However, many companies include both standard costs and variances, in addition to actual costs, in their accounts.


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23-5

Recording and Reporting Variances from Standards

Western Rider Inc. purchased, on account, the 7,300 square yards of blue denim at $5.50 per square yard. The standard price was $5.00 per square yard.


$5.50 x 7,300 = $40,150

$5.00 x 7,300 = $36,500

$3,650 U Direct materials price variance

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23-5

Western Rider Inc.’s Purchase of Materials Entry

Materials (7,300 sq. yds. x $5.00) 36 500 00

Direct Materials Price Variance3 650 00

Accounts Payable (7,300 sq. yds.

x $5.50) 40 150 00

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23-5

Western Rider Inc. used 7,300 square yards of blue denim to produce 5,000 pairs of XL jeans, compared to the standard of 7,500 square yards.


Direct materials quantity variance

$5.00 x 7,500 = $37,500

$5.00 x 7,300 = $36,500

$(1,000) F

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23-5

Work in Process (7,500 sq. yds. x $5) 37 500 00

Direct Materials Quantity Variance1 000 00

Materials (7,300 sq. yds. x $5)36 500 00

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Example Exercise 23-5

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23-5

Tip Top Corp. produced 3,000 units of product that required six standard pounds per unit at $4.50 standard price per pound. The company actually used 18,500 pounds in production. Journalize the entry to record the standard direct materials used in production.

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Follow My Example 23-5

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23-5

Work in Process (18,000* x $4.50)81,000

Direct Materials Quantity Variance [(18,500 pounds – 18,000 pounds) x $4.50]2,250

Materials83,250

*3,000 units x 6 pounds per unit = 18,000 standard pounds for units produced

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For Practice: PE23-5A, PE23-5B


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23-5

Variances from Standards in Income Statement

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Example Exercise 23-6

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23-5

Prepare an income statement for the year ended December 31, 2008 through gross profit for Tip Top Corp. using the variance data in Example Exercise 23-1 through Example Exercise 23-4. Assume Tip Top sold 3,000 units at $100 per unit.

Click for EE 23-3

Click for EE 23-1

Click for EE 23-2

Click for EE 23-4

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To return to this slide, type “62’ and press “Enter.”


Follow My Example 23-6

*Direct materials (3,000 units x 6 pounds x $4.50)$ 81,000

Direct labor (3,000 units x 2.5 hours x $12.00)90,000

Factory overhead [3,000 units x 2.5 hours x $2.20 x $0.50)] 23,250

Cost of goods sold at standard$194,250

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23-5

TIP TOP CORP.

INCOME STATEMENT THROUGH GROSS PROFIT For the Year Ended December 31, 2008

Sales (3,000 units x $100)$300,000

Cost of goods sold—at standard 194,250*

Gross profit—at standard$105,750

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(Continued)


FavorableUnfavorable

Less variances fromstandard cost:

Direct materials price$2,775

Direct materials quantity$2,250

Direct labor rate2,226

Direct labor time960

Factory overhead controllable350

Factory overhead volume 450 1,541

Gross Profit$104,209

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23-5

Follow My Example 23-6 (continued)

Gross profit—at standard (from Slide 61)$105,750

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For Practice: PE23-5A, PE23-5B


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23-6

Objective 6

Explain and provide examples of nonfinancial performance measures.


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23-6

Nonfinancial Performance Measures

A nonfinancial performancemeasure is a performance measure expressed in units other than dollars.


Inventory turnover

Percent 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

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23-6

Nonfinancial Performance Measures


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23-6

Nonfinancial measures can be linked to either the input or outputs of an activity or process. A processis a sequence of activities linked together for performing a particular task.


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23-6

Nonfinancial Performance Measures for the Counter Service Activity of a Fast Food Restaurant

Inputs

Employee training

Employee experience

Number of new menu items

Number of employees

Fryer reliability

Fountain supply availability

Outputs

Line wait

Percent order accuracy

Friendly service score

Activity

Counter service

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Example Exercise 23-7

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23-6

The following are inputs and outputs to the baggage claim process of an airline.

Baggage handling training

Time customers wait for returned baggage

Maintenance of baggage handling equipment

Number of baggage handlers

Number of damaged bags

On-time flight performance

Identify whether each is an input or an output to the baggage claim process.

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Follow My Example 23-7

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23-6

Baggage handling training

Time customers wait for returned baggage

Maintenance of baggage handling equipment

Number of baggage handlers

Number of damaged bags

On-time flight performance

Input

Output

Input

Input

Output

Input

71

For Practice: PE23-7A, PE23-7B


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