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Performance Evaluation. Chapter 8. Preparing Flexible Budgets. Hmm! Comparing static budgets with actual costs is like comparing apples and oranges. Static budgets are prepared for a single, planned level of activity.

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Performance evaluation

Performance Evaluation

Chapter 8


Preparing flexible budgets

Preparing Flexible Budgets

Hmm! Comparingstatic budgets withactual costs is likecomparing applesand oranges.

Static budgetsare prepared for asingle, planned levelof activity.

Performance evaluation is difficult when actual activity differs from the planned level of activity.

Let’s look at Melrose Co.


Preparing flexible budgets1

Preparing Flexible Budgets

F = Favourable varianceActual sales exceededbudgeted level of sales.


Preparing flexible budgets2

Preparing Flexible Budgets


Preparing flexible budgets3

Preparing Flexible Budgets

Would you expect thesevariances to be favourableor unfavourable giventhe favourable sales variance?


Preparing flexible budgets4

Preparing Flexible Budgets

I don’t think Ican answer thequestion usinga static budget.

Actual activity is belowbudgeted activity which is unfavorable.

So, shouldn’t variable costsbe lower if actual activityis lower?


Preparing flexible budgets5

Preparing Flexible Budgets

  • The relevant question is . . .

    • “What portion of the variances is due to activity and price changes, and whatportion is due to cost control?”

    • To answer the question, we must the budget for theactual activity.


Preparing flexible budgets6

Preparing Flexible Budgets

Show revenues and expensesthat should have occurred at theactual activity.

May be prepared for any activity level in the relevant range.

Reveal variances due to good cost

control or lack of cost control.

Improve performance evaluation.


Preparing flexible budgets7

Preparing Flexible Budgets

Central Concept

If you can tell me what your activity wasfor the period, I will tell you what your costs and revenue should have been.


Preparing flexible budgets8

Preparing Flexible Budgets

To a budget for different activitylevels, we must know how costs behave with changes in activity levels.

Total variablecostschange in directproportion to changes in activity.

Total fixedcostsremain unchangedwithin the relevantrange.

Variable

Fixed


Preparing flexible budgets9

Preparing Flexible Budgets

Let’s prepare budgets for the Melrose Co.


Preparing flexible budgets10

Preparing Flexible Budgets

18,000 units× $12.00 per unit = $216,000


Preparing flexible budgets11

Preparing Flexible Budgets


Preparing flexible budgets12

Preparing Flexible Budgets

“What portion of the variances is due to activity and price changes, and what portion is due tocost control?”


Sales and cost variances

Sales and Cost Variances

Sales price variance 19,000 units × ($80 per unit – $78 per unit)

Variances due toactivity change


Sales and cost variances1

Sales and Cost Variances

Variances dueto cost control


Standard costs

Standard Costs

We will use standard costs analysis to determine the causes for manufacturing cost variances.


Establishing standards

Establishing Standards

Based on carefullypredetermined amounts.

Used for planning labor, material,and overhead requirements.

Standard Costs are

The expected levelof performance.

Benchmarks formeasuring performance.


Establishing standards1

Establishing Standards

Accountants, engineers, personnel administrators, and production managers combine efforts to set standards based on experience and expectations.


Establishing standards2

Establishing Standards

Practical standardsshould be set at levelsthat are currentlyattainable withreasonable andefficient effort.

Should we usepractical standardsor ideal standards?

ManagerialAccountant

Engineer


Establishing standards3

Lax standardscreatemotivational problems.

Establishing Standards

I agree.Idealstandards, basedon perfection, areunattainable and discourage most employees.

HumanResourcesManager

Productionmanager


Need for standards

Need for Standards

Managers focus on quantities and coststhat exceed standards, a practice known asmanagement by exception..

Standard

Amount

DirectMaterial

DirectLabour

ManufacturingOverhead

Type of Product Cost


Selecting variances to investigate

Selecting Variances to Investigate

  • Materiality, frequency, capacity to control, and characteristics of the cost are items to consider.

How do I knowwhich variancesto investigate?


Manufacturing cost variances

This variance isunfavourablebecause the actual costexceeds the standard cost.

Manufacturing Cost Variances

A standard cost variance is the amount by whichan actual cost differs from the standard cost.

Standard

Product Cost


Manufacturing cost variances1

Manufacturing Cost Variances

First, they point to causes ofproblems and directionsfor improvement.

Second, they trigger investigations in departments having responsibility for incurring the costs.

I see that thereis an unfavourable variance.

But why arevariances important to me?


Manufacturing cost variances2

Manufacturing Cost Variances

Takecorrective actions

Identifyquestions

Receive explanations

Conduct next period’s operations

Analyze variances

Prepare standard cost performance report

Begin


Price and usage variances

Price Variance

Usage Variance

The difference betweenthe actual quantity andthe standard quantity

Price and Usage Variances

Standard Cost Variances

The difference betweenthe actual price and thestandard price


Price and usage variances1

Price and Usage Variances

Actual Quantity Actual Quantity Standard Quantity × × × Actual PriceStandard Price Standard Price

Price Variance

Usage Variance

Standard priceis the amount that should have been paid for the resources acquired.


Price and usage variances2

Price and Usage Variances

Actual Quantity Actual Quantity Standard Quantity × × × Actual PriceStandard Price Standard Price

Price Variance

Usage Variance

Standard quantityis the quantity that shouldhave been used for the output achieved.


Price and usage variances3

Price and Usage Variances

Actual Quantity Actual Quantity Standard Quantity × × × Actual PriceStandard Price Standard Price

Price Variance

Usage Variance

AQ(AP - SP) SP(AQ - SQ)

AQ = Actual QuantitySP= Standard PriceAP= Actual PriceSQ = Standard Quantity


Calculating the materials price and usage variances

Calculating the Materials Priceand Usage Variances

Let’s apply what we have learned calculate standard cost variances, starting withmaterial.


Calculating the materials price and usage variances1

Calculating the Materials Priceand Usage Variances

Zippy

Hanson Inc. has the following material standards to manufacture one Zippy:

1.5 kilograms per Zippy at $4.00 per kilogram

Last week 1,700 kilograms of material were purchased and used to make 1,000 Zippies. The material cost a total of $6,630.


Calculating the materials price and usage variances2

Calculating the Materials Priceand Usage Variances

Zippy

What is the actual price per kilogrampaid for the material?

a.$4.00 per kilogram.

b.$4.10 per kilogram.

c.$3.90 per kilogram.

d.$6.63 per kilogram.


Calculating the materials price and usage variances3

Calculating the Materials Priceand Usage Variances

Zippy

What is the actual price per kilogrampaid for the material?

a.$4.00 per kilogram.

b.$4.10 per kilogram.

c.$3.90 per kilogram.

d.$6.63 per kilogram.

AP = $6,630 ÷ 1,700 kgsAP = $3.90 per kg


Calculating the materials price and usage variances4

Calculating the Materials Priceand Usage Variances

Zippy

Hanson’s material price variance (MPV)for the week was:

a.$170 unfavourable.

b.$170 favourable.

c.$800 unfavourable.

d.$800 favourable.


Calculating the materials price and usage variances5

Calculating the Materials Priceand Usage Variances

Zippy

Hanson’s material price variance (MPV)for the week was:

a.$170 unfavourable.

b.$170 favourable.

c.$800 unfavourable.

d.$800 favourable.

MPV = AQ(AP - SP) MPV = 1,700kgs. × ($3.90 - 4.00) MPV = $170 Favourable


Calculating the materials price and usage variances6

Calculating the Materials Priceand Usage Variances

Zippy

The standard quantity of material thatshould have been used to produce1,000 Zippies is:

a.1,700 kilograms.

b.1,500 kilograms.

c.2,550 kilograms.

d.2,000 kilograms.


Calculating the materials price and usage variances7

Calculating the Materials Priceand Usage Variances

Zippy

The standard quantity of material thatshould have been used to produce1,000 Zippies is:

a.1,700 kilograms.

b.1,500 kilograms.

c.2,550 kilograms.

d.2,000 kilograms.

SQ = 1,000 units × 1.5 kgs per unit SQ = 1,500 kgs.


Calculating the materials price and usage variances8

Calculating the Materials Priceand Usage Variances

Zippy

Hanson’s material usage variance (MUV)for the week was:

a.$170 unfavourable.

b.$170 favourable.

c.$800 unfavourable.

d.$800 favourable.


Calculating the materials price and usage variances9

MUV = SP(AQ - SQ) MUV = $4.00(1,700 kgs - 1,500 kgs) MUV = $800 unfavourable

Calculating the Materials Priceand Usage Variances

Zippy

Hanson’s material usage variance (MUV)for the week was:

a.$170 unfavourable.

b.$170 favourable.

c.$800 unfavourable.

d.$800 favourable.


Material variances summary

Material Variances Summary

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price

1,700 kgs. 1,700 kgs. 1,500 kgs. × × × $3.90 per kg. $4.00 per kg. $4.00 per kg.

=$6,630 = $ 6,800 = $6,000

Price variance$170 favorable

Usage variance$800 unfavorable


Responsibility for materials variances

I’ll start computingthe price varianceas soon as theinformation isavailable.

Responsibility for Materials Variances

I need the price variancesooner so that I can betteridentify purchasing problems.

You accountants just don’tunderstand the problems thatpurchasing managers have.


Responsibility for materials variances1

You used too much material because of poorly trained workers and poorly maintained equipment.

Also, your poor scheduling sometimes requires me to rush order material at a higher price, causing unfavourable price variances.

Responsibility for Materials Variances

I am not responsible for this unfavourable materialusage variance.

You purchased cheapmaterial, so my peoplehad to use more of it.


Labour variances

Labour Variances

Now let’s calculate standard cost variances for labour.


Labour variances1

Labour Variances

Zippy

Hanson Inc. has the following direct labour standard to manufacture one Zippy:

1.5 standard hours per Zippy at $6.00 perdirect labour hour

Last week 1,550 direct labour hours were worked at a total labor cost of $9,610 to make 1,000 Zippies.


Labour variances2

Labour Variances

Zippy

What was Hanson’s actual price (AP)for labor for the week?

a.$6.20 per hour.

b.$6.00 per hour.

c.$5.80 per hour.

d.$5.60 per hour.


Labour variances3

Labour Variances

Zippy

What was Hanson’s actual price (AP)for labour for the week?

a.$6.20 per hour.

b.$6.00 per hour.

c.$5.80 per hour.

d.$5.60 per hour.

AP = $9,610 ÷ 1,550 hours AP = $6.20 per hour


Labour variances4

Labour Variances

Zippy

Hanson’s labour price variance (LPV) for the week was:

a.$310 unfavourable.

b.$310 favourable.

c.$300 unfavourable.

d.$300 favourable.


Labour variances5

Labour Variances

Zippy

Hanson’s labour price variance (LPV) for the week was:

a.$310 unfavourable.

b.$310 favourable.

c.$300 unfavourable.

d.$300 favourable.

LPV = AH(AP - SP) LPV = 1,550 hrs($6.20 - $6.00) LPV = $310 unfavourable


Labour variances6

Labour Variances

Zippy

The standard hours (SH) of labour that should have been worked to produce1,000 Zippies is:

a.1,550 hours.

b.1,500 hours.

c.1,700 hours.

d.1,800 hours.


Labour variances7

SH = 1,000 units × 1.5 hours per unit SH = 1,500 hours

Labour Variances

Zippy

The standard hours (SH) of labour that should have been worked to produce1,000 Zippies is:

a.1,550 hours.

b.1,500 hours.

c.1,700 hours.

d.1,800 hours.


Labour variances8

Labour Variances

Zippy

Hanson’s labour usage variance (LUV)for the week was:

a.$290 unfavourable.

b.$290 favourable.

c.$300 unfavourable.

d.$300 favourable.


Labour variances9

LUV = SP(AH - SH) LUV = $6.00(1,550 hrs - 1,500 hrs) LUV = $300 unfavourable

Labour Variances

Zippy

Hanson’s labour usage variance (LUV)for the week was:

a.$290 unfavourable.

b.$290 favourable.

c.$300 unfavourable.

d.$300 favourable.


Labour variances10

Actual Hours Actual Hours Standard Hours × × × Actual Price Standard Price Standard Price

Price variance$310 unfavourable

Usage variance$300 unfavourable

Labour Variances

Zippy

1,550 hours 1,550 hours 1,500 hours × × × $6.20 per hour $6.00 per hour $6.00 per hour

= $9,610 = $9,300 = $9,000


Responsibility for labour variances

Responsibility for Labour Variances

Using highly paid skilled workers toperform unskilled tasks results in anunfavourable rate variance.

High skill,high rate

Low skill,low rate

Production managers who make work assignmentsare generally responsible for rate variances.


Responsibility for labour variances1

Responsibility for Labour Variances

Poorlytrainedworkers

Poorqualitymaterials

UnfavourableUsage

Variance

Poorsupervisionof workers

Poorlymaintainedequipment


Responsibility for labour variances2

You used too much time because of poorly trained workers and poor supervision.

Responsibility for Labour Variances

I am not responsible for the unfavourable laborusage variance!

You purchased cheapmaterial, so it took moretime to process it.


Responsibility for labour variances3

Responsibility for Labour Variances

Maybe I can attribute the laborand material variances to personnel for hiring the wrong peopleand training them poorly.


Variable overhead variances

Variable Overhead Variances

Many companies do not calculate price and usage variances for variable overhead.

Flexible budget variances are used to evaluate variable overhead cost control.


Fixed overhead variances

Fixed Overhead Variances

Now let’s turn our attention tofixed overhead.


Fixed overhead variances1

Fixed Overhead Variances

Overhead costs are assigned to products and services using a predetermined overhead rate (POHR):

Assigned Overhead = POHR × Standard Activity

Fixed Overhead Budget

POHR =

Static Budget Activity


Performance evaluation

Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied

SH× POHR

Spending Variance

VolumeVariance

POHR= Fixed Overhead RateSH= Standard Hours Allowed

Fixed Overhead Variances


Fixed overhead variances2

Fixed Overhead Variances

Zippy

Hanson Inc. has the following budgeted and actual fixed overhead information:

Calculate the fixed overhead spendingand volume variances.


Fixed overhead variances3

Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied

SH× POHR

1,500 hours × $3.00 per hour

$5,250

$5,400

$4,500

Spending variance$150 favourable

Volume variance$900 unfavourable

Fixed Overhead Variances

Zippy


Fixed overhead variances4

Spending Variance

Volume Variance

Fixed Overhead Variances

Results from paying moreor less than expected foroverhead items.

Results from operatingat an activity leveldifferent from theplanned activity.


Volume variance a closer look

Volume Variance - A Closer Look

VolumeVariance

Results when standard hoursallowed for actual output differsfrom the budgeted activity.

Unfavourablewhen standard hours< budgeted hours

Favourablewhen standard hours> budgeted hours


Volume variance a closer look1

VolumeVariance

Results when standard hoursallowed for actual output differsfrom the budgeted activity.

Unfavorablewhen standard hours< budgeted hours

Favorablewhen standard hours> budgeted hours

Volume Variance - A Closer Look

Does not measure over- or under spending

Explainable by and controllable only throughactivity


End of chapter 8

End of Chapter 8

We made it!


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