The standard-setting process normally requires the joint efforts of accountants

1. 0 23 Performance Evaluation Using Variances From Standard Costs

2. 0 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.

3. 0 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.

4. 0 After studying this chapter, you should be able to: • Explain and provide examples of nonfinancial performance measures.

5. 0 23-1 Objective 1 Describe the types of standards and how they are established for businesses.

6. 0 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

7. 0 23-1 Accounting systems that use standards for direct materials, direct labor, and factory overhead are called standard cost systems.

8. 0 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).

9. The standard-setting process normally requires the joint effortsof accountants, engineers, and other management personnel. 0 23-1 Setting Standards

10. 0 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.

11. 0 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.

12. 0 23-1 Reviewing and Revising Standards Standard costs should be continuously reviewed and should be revised when they no longer reflect operating conditions.

13. 0 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)

14. 0 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.

15. 0 23-2 Objective 2 Explain and illustrate how standards are used in budgeting.

16. 0 23-2 Standard Cost for XL Jeans 16

17. 0 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).

18. 0 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).

19. 0 23-2 Budget Performance Report 19

20. 0 23-2 Relationship of Variances to the Total Manufacturing Cost Variances 20

21. 0 23-3 Objective 3 Compute and interpret direct materials and direct labor variances.

22. 0 23-3 Direct Materials Standard square yards per pair of jeans 1.50 sq. yards Actual units produced x 5,000 pairs of jeans Standard square yards of denim budgeted for actual production 7,500 sq. yards Standard price per sq. yd. x $5.00 Standard direct materials cost at actual production $37,500 22

23. 0 23-3 Direct Materials Price Variance Actual price per unit $5.50 per sq. yd. Standard price per unit 5.00 per sq. yd. Price variance (unfavorable) $0.50 per sq. yd. $0.50 x the actual quantity of 7,300 sq. yds. =$3,650 unfavorable price variance 23

24. 0 23-3 Direct Materials Quantity Variance Actual quantity used 7,300 sq. yds. Standard quantity at actual production 7,500 Quantity variance (favorable) (200) sq. yds. (200) square yards x the standard price of $5.00 = ($1,000) favorable 24

25. 0 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 25 (Continued)

26. 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 0 23-3 Direct Materials Variance Relationships Actual cost: Standard cost: Total direct materials cost variance $2,650 U 26 (Concluded)

27. Example Exercise 23-1 0 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? 27

28. Follow My Example 23-1 0 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 28 For Practice: PE23-1A, PE23-1B

29. 0 23-3 Direct Labor Variances Standard direct labor hours per pair 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 29

30. 0 23-3 Direct Labor Rate Variance Actual rate $10.00 Standard rate 9.00 Rate variance—unfavorable $ 1.00 per hour $1.00 x the actual time of 3,850 hours =$3,850 unfavorable 30

31. 0 23-3 Direct Labor Time Variance Actual hours 3,850 DLH Standard hours at actual production 4,000 Time variance—favorable (150) DLH (150) Direct labor hours x the standard rate of $9.00 =($1,350) favorable 31

32. 4 0 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 32 (Continued)

33. 4 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 0 23-3 Direct Labor Variance Relationships Actual cost: Standard cost: Total direct labor cost variance $2,500 U 33 (Concluded)

34. Example Exercise 23-2 0 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? 34

35. Follow My Example 23-2 0 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 35 For Practice: PE23-2A, PE23-2B

36. 0 23-4 Objective 4 Compute and interpret factory overhead controllable and volume variances.

37. 0 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.

38. 0 23-4 Factory Overhead Cost Budget Indicating Standard Factory Overhead Rate 38

39. 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. 0 Variances from standard for factory overhead cost result from: 23-4 The Factory Overhead Flexible Budget

40. 0 23-4 Variable Factory Overhead Controllable Variance Actual variable factory overhead $ 10,400 Budgeted variable factory overhead for actual amount produced (4,000 hrs. x $3.60) 14,400 Controllable variance— favorable $ (4,000) F 40

41. Example Exercise 23-3 0 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. 41

42. Follow My Example 23-3 0 23-4 $350 unfavorable $16,850 – [$2.20 x (3,000 units x 2.5 hours)] 42 For Practice: PE23-3A, PE23-3B

43. 0 23-4 Fixed Factory Overhead Volume Variance 100% of normal capacity 5,000 direct labor hours Standard hours at actual production 4,000 Capacity not used 1,000 direct labor hours Standard fixed overhead rate x $2.40 Volume variance—unfavorable $ 2,400 U 43

44. 0 23-4 44

45. Example Exercise 23-4 0 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. 45

46. Follow My Example 23-4 0 23-4 $450 unfavorable $0.90 x [8,000 hours – (3,000 units x 2.5 hours)] 46 For Practice: PE23-4A, PE23-4B

47. 0 23-4 Reporting Factory Overhead Variances Total actual factory overhead $22,400 Factory overhead applied (4,000 hours x $6.00 per hour) 24,000 Total factory overhead cost variance—favorable $(1,600) F 47

48. 0 23-4 Factory Overhead Cost Variance Report 48

49. 4,000 hours x $6.00 per hour $10,400 + $12,000 0 23-4 Factory Overhead Variances and the Factory Overhead Account Factory Overhead Actual factory overhead 22,400 Applied factory overhead 24,000 49

50. Factory Overhead Actual factory overhead 22,400 Applied factory overhead 24,000 Balance, June 30 1,600 0 23-4 Overapplied factory overhead 50