Text. A Look at This Chapter

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1 24 Standard Flexble Budgets and Costs A Look Back Chapter 23 explaned the master budget and ts component budgets as well as ther usefulness for plannng and montorng company actvtes. A Look at Ths Chapter Ths chapter descrbes flexble budgets, varance analyss, and standard costs. It explans how each s used for purposes of better controllng and montorng busness actvtes. A Look Ahead Chapter 25 focuses on captal budgetng decsons. It also explans and llustrates several procedures used n evaluatng short-term manageral decsons. Learnng Objectves CAP Conceptual C1 C2 C3 Defne standard costs and explan ther computaton and uses. (p. 959) Descrbe varances and what they reveal about performance. (p. 961) Explan how standard cost nformaton s useful for management by excepton. (p. 970) Analytcal A1 A2 Compare fxed and flexble budgets. (p. 956) Analyze changes n sales from expected amounts. (p. 972) Procedural P1 P2 P3 P4 Prepare a flexble budget and nterpret a flexble budget performance report. (p. 957) Compute materals and labor varances. (p. 962) Compute overhead varances. (p. 966) Prepare journal entres for standard costs and account for prce and quantty varances. (p. 971)

2 Create what the ndustry s mssng...t s worth the hardshps Kevn Plank (center) Decson Feature Standards for Performance Apparel BALTIMORE, MD Kevn Plank s company, Under Armour (UnderArmour.com), manufactures a polyester blend fabrc that whsks perspraton away from the skn. There was a vod n apparel and I decded to fll t, says Kevn. He nvested hs lfe savngs of $20,000 and began workng out of hs grandma s basement. In the process, Kevn launched an entrely new sportswear category from sweaty undergarments. As sales grew, Kevn partnered wth a factory n Oho that had excess capacty and ht t off wth the factory manager, Sal Fascana. Sal spent many evenngs and weekends teachng Kevn about manufacturng, cost management, and accountng. It was Sal who ntroduced Kevn to budgets and varances. I sad, OK, kd.ths s the way t s gong to be done, recalls Sal.To save money for nvestng n hs new company, Kevn even moved nto a spare room n Sal and hs wfe s home, lvng on Sal s lasagna and Froot Loops. Kevn appled what Sal taught hm. He ensured the budgeted numbers were sensble and focused on meetng qualty standards regardng materals, labor, and overhead. We can only be concerned about ourselves and the job [that] we do, nssts Kevn.The company adheres to tght standards varances. For nstance, when a new product faled to meet standards, Kevn quckly pulled t and Under Armour took a $600,000 ht n nventory. Says Kevn, It s hard to take a $600,000 ht [but] money can be replaced. Kevn adheres to strct budgets and standards because, as he puts t, The best product we manufacture s our story. Lose the story, and a company s edge s next. A commtment to performance reportng and qualty standards s propellng Under Armour s sales toward $300 mllon and shatterng Kevn s most optmstc budget goals. It s about educatng consumers... nvestng n the product. Kevn also apples cost analyss and varances, flexble and fxed budgets, and performance reports. Sales varances are especally crucal to producton prcng because the polyester-blend fabrc that Kevn uses costs two to three tmes as much as cotton. When I frst started...i was a young punk who thought he knew everythng, explans Kevn. Although Kevn admts that nsght and ngenuty are vtal, he knows accountng reports must show profts for long-term success. Most people out there are sayng we re gong to trp up at some pont, says Kevn. Our job s to prove them wrong. He mght also prove Thomas Edson rght: genus s 99 percent perspraton and 1 percent nspraton. [Sources: Under Armour Webste, May 2006; Entrepreneur, November 2003; FastCompany, 2005 and 2002; USA Today, December 2004; Inc.com, 2003 and 2004; All Headlne News, August 2005; Baltmore Busness Journal, February 2006]

3 Chapter Prevew Budgetng helps organze and formalze management s plannng actvtes. Ths chapter extends the study of budgetng to look more closely at the use of budgets to evaluate performance. Evaluatons are mportant for controllng and montorng busness actvtes. Ths chapter also descrbes and llustrates the use of standard costs and varance analyses. These manageral tools are useful for both evaluatng and controllng organzatons and for the plannng of future actvtes. Flexble Budgets Budgetary Process Control and reportng Fxed budget performance report Evaluaton Flexble Budget Reports Purpose Preparaton Flexble budget performance report Materals and Labor Standards Identfyng materals and labor standards Settng standard costs Cost Varances Analyss process Computaton Materals and labor varances Overhead Standards and Varances Settng overhead standards Usng varance analyss Computng varances Secton 1 Flexble Budgets Ths secton ntroduces fxed budgets and fxed budget performance reports. It then ntroduces flexble budgets and flexble budget performance reports and llustrates ther advantages. Budgetary Process A master budget reflects management s planned objectves for a future perod. The preparaton of a master budget s based on a predcted level of actvty such as sales volume for the budget perod. Ths secton dscusses the effects on the usefulness of budget reports when the actual level of actvty dffers from the predcted level. Pont: Budget reports are often used as a base to determne bonuses of managers. Budgetary Control and Reportng Budgetary control refers to management s use of budgets to montor and control a company s operatons. Ths ncludes usng budgets to see that planned objectves are met. Budget reports contan relevant nformaton that compares actual results to planned actvtes. Ths comparson s motvated by a need to both montor performance and control actvtes. Budget reports are sometmes vewed as progress reports, or report cards, on management s performance n achevng planned objectves. These reports can be prepared at any tme and for any perod. Three common perods for a budget report are a month, quarter, and year. The budgetary control process nvolves at least four steps: (1) develop the budget from planned objectves, (2) compare actual results to budgeted amounts and analyze any dfferences, (3) take correctve and strategc actons, and (4) establsh new planned objectves and prepare a new budget. Exhbt 24.1 shows ths contnual process of budgetary control. Budget

4 Chapter 24 Flexble Budgets and 955 Actual vs. Budget Hbkvfdnvk fns; ds,d sjblv skb0l cghs s k kjhfv kdhac;,nchjdg jvkfd hfewfj jlkjfo kjnv Hbkvfdnvk fns; ds,d sjblv skb0l cghs s k kjhfv kdhac;,nchjdg jvkfd hfewfj jlkjfo kjnv Hbkvfdnvk fns; ds,d sjblv skb0l cghs s k kjhfv kdhac;,nchjdg jvkfd hfewfj jlkjfo Hbkvfdnvk fns; ds,d sjblv skb0l cghs s k kjhfv kdhac;,nchjdg jvkfd hfewfj jlkjfo Exhbt 24.1 Process of Budgetary Control Develop Budget Compare Actual to Budget Take Acton Set New Plans reports and related documents are effectve tools for managers to obtan the greatest benefts from ths budgetary process. Fxed Budget Performance Report In a fxed budgetary control system, the master budget s based on a sngle predcton for sales volume or other actvty level. The budgeted amount for each cost essentally assumes that a specfc (or fxed) amount of sales wll occur. A fxed budget, also called statc budget, s based on a sngle predcted amount of sales or other measure of actvty. One beneft of a budget s ts usefulness n comparng actual results wth planned actvtes. Informaton useful for analyss s often presented for comparson n a performance report. As shown n Exhbt 24.2, a fxed budget performance report for Optel compares actual results for January 2008 wth the results expected under ts fxed budget that predcted 10,000 (composte) unts of sales. Optel manufactures nexpensve eyeglasses, frames, contact lens, and related supples. For ths report, ts producton volume equals sales volume (ts nventory level dd not change). OPTEL Fxed Budget Performance Report For Month Ended January 31, 2008 Fxed Actual Budget Results Varances* Exhbt 24.2 Fxed Budget Performance Report Sales (n unts) ,000 12,000 Sales (n dollars) $100,000 $125,000 $25,000 F Cost of goods sold Drect materals ,000 13,000 3,000 U Drect labor ,000 20,000 5,000 U Overhead Factory supples ,000 2, U Utltes ,000 4,000 1,000 U Deprecaton Machnery ,000 8,000 0 Supervsory salares ,000 11,000 0 Sellng expenses Sales commssons ,000 10,800 1,800 U Shppng expenses ,000 4, U General and admnstratve expenses Offce supples ,000 5, U Insurance expenses ,000 1, U Deprecaton Offce equpment ,000 7,000 0 Admnstratve salares ,000 13,000 0 Total expenses ,000 99,600 11,600 U Income from operatons $ 12,000 $ 25,400 $13,400 F * F Favorable varance; and U Unfavorable varance.

5 956 Chapter 24 Flexble Budgets and Example: How s t that the favorable sales varance n Exhbt 24.2 s lnked wth so many unfavorable cost and expense varances? Answer: Costs have ncreased wth the ncrease n sales. Decson Insght Green Budget Budget reportng and evaluaton are used at the Envronmental Protecton Agency (EPA). It regularly prepares performance plans and budget requests that descrbe performance goals, measure outcomes, and analyze varances. Ths type of performance report desgnates dfferences between budgeted and actual results as varances. We see the letters F and U located besde the numbers n the thrd number column of ths report. Ther meanngs are as follows: F Favorable varance When compared to budget, the actual cost or revenue contrbutes to a hgher ncome. That s, actual revenue s hgher than budgeted revenue, or actual cost s lower than budgeted cost. U Unfavorable varance When compared to budget, the actual cost or revenue contrbutes to a lower ncome; actual revenue s lower than budgeted revenue, or actual cost s hgher than budgeted cost. Ths conventon s common n practce and s used throughout ths chapter. Budget Reports for Evaluaton A prmary use of budget reports s as a tool for management to montor and control operatons. Evaluaton by Optel management s lkely to focus on a varety of questons that mght nclude these: Why s actual ncome from operatons $13,400 hgher than budgeted? Are amounts pad for each expense tem too hgh? Is manufacturng usng too much drect materal? Is manufacturng usng too much drect labor? The performance report n Exhbt 24.2 provdes lttle help n answerng these questons because actual sales volume s 2,000 unts hgher than budgeted. A manager does not know f ths hgher level of sales actvty s the cause of varatons n total dollar sales and expenses or f other factors have nfluenced these amounts. Ths nablty of fxed budget reports to adjust for changes n actvty levels s a major lmtaton of a fxed budget performance report. That s, t fals to show whether actual costs are out of lne due to a change n actual sales volume or some other factor. Flexble Budget Reports A1 Topc Tackler 24-1 Compare fxed and flexble budgets. PLUS Purpose of Flexble Budgets To help address lmtatons wth the fxed budget performance report, partcularly from the effects of changes n sales volume, management can use a flexble budget. A flexble budget, also called a varable budget, s a report based on predcted amounts of revenues and expenses correspondng to the actual level of output. Flexble budgets are useful both before and after the perod s actvtes are complete. A flexble budget prepared before the perod s often based on several levels of actvty. Budgets for those dfferent levels can provde a what f look at operatons. The dfferent levels often nclude both a best case and worst case scenaro. Ths allows management to make adjustments to avod or lessen the effects of the worst case scenaro. A flexble budget prepared after the perod helps management evaluate past performance. It s especally useful for such an evaluaton because t reflects budgeted revenues and costs based on the actual level of actvty. Thus, comparsons of actual results wth budgeted performance are more lkely to dentfy the causes of any dfferences. Ths can help managers focus attenton on real problem areas and mplement correctve actons. Ths s n contrast to a fxed budget, whose prmary purpose s to assst managers n plannng future actvtes and whose numbers are based on a sngle predcted amount of budgeted sales or producton.

6 Chapter 24 Flexble Budgets and 957 Preparaton of Flexble Budgets A flexble budget s desgned to reveal the effects of volume of actvty on revenues and costs. To prepare a flexble budget, management reles on the dstnctons between fxed and varable costs. Recall that the cost per unt of actvty remans constant for varable costs so that the total amount of a varable cost changes n drect proporton to a change n actvty level. The total amount of fxed cost remans unchanged regardless of changes n the level of actvty wthn a relevant (normal) operatng range. (Assume that costs can be reasonably classfed as varable or fxed wthn a relevant range.) When we create the numbers consttutng a flexble budget, we express each varable cost as ether a constant amount per unt of sales or as a percent of a sales dollar. In the case of a fxed cost, we express ts budgeted amount as the total amount expected to occur at any sales volume wthn the relevant range. Exhbt 24.3 shows a set of flexble budgets for Optel n January Seven of ts expenses are classfed as varable costs. Its remanng fve expenses are fxed costs. These classfcatons result from management s nvestgaton of each expense. Varable and fxed expense categores are not the same for every company, and we must avod drawng conclusons from specfc cases. For example, dependng on the nature of a company s operatons, offce supples expense can be ether fxed or varable wth respect to sales. Prepare a flexble P1 budget and nterpret a flexble budget performance report. Pont: Usefulness of a flexble budget depends on vald classfcaton of varable and fxed costs. Some costs are mxed and must be analyzed to determne ther varable and fxed portons. OPTEL Flexble Budgets For Month Ended January 31, 2008 Flexble Budget Flexble Flexble Flexble Budget Budget Budget Varable Total for Unt for Unt for Unt Amount Fxed Sales of Sales of Sales of per Unt Cost 10,000 12,000 14,000 Exhbt 24.3 Flexble Budgets Sales $10.00 $100,000 $120,000 $140,000 Varable costs Drect materals ,000 12,000 14,000 Drect labor ,000 18,000 21,000 Factory supples ,000 2,400 2,800 Utltes ,000 3,600 4,200 Sales commssons ,000 10,800 12,600 Shppng expenses ,000 4,800 5,600 Offce supples ,000 6,000 7,000 Total varable costs ,000 57,600 67,200 Contrbuton margn $ 5.20 $ 52,000 $ 62,400 $ 72,800 Fxed costs Deprecaton Machnery $ 8,000 8,000 8,000 8,000 Supervsory salares ,000 11,000 11,000 11,000 Insurance expense ,000 1,000 1,000 1,000 Deprecaton Offce equpment ,000 7,000 7,000 7,000 Admnstratve salares ,000 13,000 13,000 13,000 Total fxed costs $40,000 40,000 40,000 40,000 Income from operatons $ 12,000 $ 22,400 $ 32,800 The layout for the flexble budgets n Exhbt 24.3 follows a contrbuton margn format begnnng wth sales followed by varable costs and then fxed costs. Both the expected ndvdual and total varable costs are reported and then subtracted from sales. The dfference between sales and varable costs equals contrbuton margn. The expected amounts of fxed costs are lsted next, followed by the expected ncome from operatons before taxes. Example: Usng Exhbt 24.3, what s the budgeted ncome from operatons for unt sales of (a) 11,000 and (b) 13,000? Answers: $17,200 for unt sales of 11,000. $27,600 for unt sales of 13,000.

7 958 Chapter 24 Flexble Budgets and Pont: Flexble budgetng allows a budget to be prepared at the actual output level. Performance reports are then prepared comparng the flexble budget to actual revenues and costs. Pont: A flexble budget yelds an apples to apples comparson because budgeted actvty levels are the same as the actual. The frst and second number columns of Exhbt 24.3 show the flexble budget amounts for varable costs per unt and each fxed cost for any volume of sales n the relevant range. The thrd, fourth, and ffth columns show the flexble budget amounts computed for three dfferent sales volumes. For nstance, the thrd column s flexble budget s based on 10,000 unts. These numbers are the same as those n the fxed budget of Exhbt 24.2 because the expected volumes are the same for these two budgets. Recall that Optel s actual sales volume for January s 12,000 unts. Ths sales volume s 2,000 unts more than the 10,000 unts orgnally predcted n the master budget. When dfferences between actual and predcted volume arse, the usefulness of a flexble budget s apparent. For nstance, compare the flexble budget for 10,000 unts n the thrd column (whch s the same as the fxed budget n Exhbt 24.2) wth the flexble budget for 12,000 unts n the fourth column. The hgher levels for both sales and varable costs reflect nothng more than the ncrease n sales actvty. Any budget analyss comparng actual wth planned results that gnores ths nformaton s less useful to management. To llustrate, when we evaluate Optel s performance, we need to prepare a flexble budget showng actual and budgeted values at 12,000 unts. As part of a complete proftablty analyss, managers could compare the actual ncome of $25,400 (from Exhbt 24.2) wth the $22,400 ncome expected at the actual sales volume of 12,000 unts (from Exhbt 24.3). Ths results n a total ncome varance of $3,000 to be explaned and nterpreted. Ths varance s markedly dfferent from the $13,400 varance dentfed n Exhbt 24.2 usng a fxed budget. After recevng the flexble budget based on January s actual volume, management must determne what caused ths $3,000 dfference. The next secton descrbes a flexble budget performance report that provdes gudance n ths analyss. Flexble Budget Performance Report A flexble budget performance report lsts dfferences between actual performance and budgeted performance based on actual sales volume or other actvty level. Ths report helps drect management s attenton to those costs or revenues that dffer substantally from budgeted amounts. Exhbt 24.4 shows Optel s flexble budget performance report for January. We prepare ths report after the actual volume s known to be 12,000 unts. Ths report shows a $5,000 favorable varance n total dollar sales. Because actual and budgeted volumes are both 12,000 unts, the $5,000 sales varance must have resulted from a hgher than expected sellng prce. Further analyss of the facts surroundng ths $5,000 sales varance reveals a favorable sales varance per unt of nearly $0.42 as shown here: Actual average prce per unt (rounded to cents) $125,000 12,000 $10.42 Budgeted prce per unt $120,000 12, Favorable sales varance per unt $5,000 12,000 $ 0.42 The other varances n Exhbt 24.4 also drect management s attenton to areas where correctve actons can help control Optel s operatons. Each expense varance s analyzed as the sales varance was. We can thnk of each expense as the jont result of usng a gven number of unts of nput and payng a specfc prce per unt of nput. Each varance n Exhbt 24.4 s due n part Decson Maker Answer p. 978 Entrepreneur The heads of both strategc consultng and tax consultng dvsons of your fnancal servces frm complan to you about the unfavorable varances on ther performance reports. We worked on more consultng assgnments than planned. It s not surprsng our costs are hgher than expected. To top t off, ths report characterzes our work as poor! How do you respond? to a dfference between actual prce per unt of nput and budgeted prce per unt of nput. Ths s a prce varance. Each varance also can be due n part to a dfference between actual quantty of nput used and budgeted quantty of nput. Ths s a quantty varance. We explan more about ths breakdown, known as varance analyss, later n the standard costs secton.

8 Chapter 24 Flexble Budgets and 959 OPTEL Flexble Budget Performance Report For Month Ended January 31, 2008 Flexble Actual Budget Results Varances* Exhbt 24.4 Flexble Budget Performance Report Sales (12,000 unts) $120,000 $125,000 $5,000 F Varable costs Drect materals ,000 13,000 1,000 U Drect labor ,000 20,000 2,000 U Factory supples ,400 2, F Utltes ,600 4, U Sales commssons ,800 10,800 0 Shppng expenses ,800 4, F Offce supples ,000 5, F Total varable costs ,600 59,400 1,800 U Contrbuton margn ,400 65,600 3,200 F Fxed costs Deprecaton Machnery ,000 8,000 0 Supervsory salares ,000 11,000 0 Insurance expense ,000 1, U Deprecaton Offce equpment ,000 7,000 0 Admnstratve salares ,000 13,000 0 Total fxed costs ,000 40, U Income from operatons $ 22,400 $ 25,400 $3,000 F * F Favorable varance; and U Unfavorable varance. Quck Check Answers p A flexble budget (a) shows fxed costs as constant amounts of cost per unt of actvty, (b) shows varable costs as constant amounts of cost per unt of actvty, or (c) s prepared based on one expected amount of budgeted sales or producton. 2. What s the ntal step n preparng a flexble budget? 3. What s the man dfference between a fxed and a flexble budget? 4. What s contrbuton margn? Secton 2 Standard costs are preset costs for delverng a product or servce under normal condtons. These costs are establshed by personnel, engneerng, and accountng studes usng past experences and data. Management uses these costs to assess the reasonableness of actual costs ncurred for producng the product or servce. When actual costs vary from standard costs, management follows up to dentfy potental problems and take correctve actons. Standard costs are often used n preparng budgets because they are the antcpated costs ncurred under normal condtons. Terms such as standard materals cost, standard labor cost, and standard overhead cost are often used to refer to amounts budgeted for drect materals, drect labor, and overhead. Defne standard costs and C1 explan ther computaton and uses. Pont: Snce standard costs are often budgeted costs, they can be used to prepare both fxed budgets and flexble budgets.

9 960 Chapter 24 Flexble Budgets and Materals and Labor Standards Pont: Busness practce often uses the word budget when speakng of total amounts and standard when dscussng per unt amounts. Decson Insght Crus n Standards The Corvette conssts of hundreds of parts for whch engneers set standards. Varous types of labor are also nvolved n ts producton, ncludng machnng, assembly, pantng, and weldng, and standards are set for each. Actual results are perodcally compared wth standards to assess performance. Ths secton explans how to set materals and labor standards and how to prepare a standard cost card. Identfyng Manageral accountants, engneers, personnel admnstrators, and other managers combne ther efforts to set standard costs. To dentfy standards for drect labor costs, we can conduct tme and moton studes for each labor operaton n the process of provdng a product or servce. From these studes, management can learn the best way to perform the operaton and then set the standard labor tme requred for the operaton under normal condtons. Smlarly, standards for materals are set by studyng the quantty, grade, and cost of each materal used. Standards for overhead costs are explaned later n the chapter. Regardless of the care used n settng standard costs and n revsng them as condtons change, actual costs frequently dffer from standard costs, often as a result of one or more factors. For nstance, the actual quantty of materal used can dffer from the standard, or the prce pad per unt of materal can dffer from the standard. Quantty and prce dfferences from standard amounts can also occur for labor. That s, the actual labor tme and actual labor rate can vary from what was expected. The same analyss apples to overhead costs. Example: What factors mght be consdered when decdng whether to revse standard costs? Answer: Changes n the processes and/or resources needed to carry out the processes. Pont: Companes promotng contnuous mprovement strve to acheve deal standards by elmnatng neffcences and waste. Exhbt 24.5 Standard Cost Card Settng To llustrate the settng of a standard cost, we consder a professonal league baseball bat manufactured by ProBat. Its engneers have determned that manufacturng one bat requres 0.90 kgs. of hgh-grade wood. They also expect some loss of materal as part of the process because of neffcences and waste. Ths results n addng an allowance of 0.10 kgs., makng the standard requrement 1.0 kg. of wood for each bat. The 0.90 kgs. porton s called an deal standard; t s the quantty of materal requred f the process s 100% effcent wthout any loss or waste. Realty suggests that some loss of materal usually occurs wth any process. The standard of 1.0 kg. s known as the practcal standard, the quantty of materal requred under normal applcaton of the process. Hgh-grade wood can be purchased at a standard prce of $25 per kg. The purchasng department sets ths prce as the expected prce for the budget perod. To determne ths prce, the purchasng department consders factors such as the qualty of materals, future economc condtons, supply factors (shortages and excesses), and any avalable dscounts. The engneers also decde that two hours of labor tme (after ncludng allowances) are requred to manufacture a bat. The wage rate s $20 per hour (better than average sklled labor s requred). ProBat assgns all STANDARD COST CARD Producton factor Cost factor Total Drect materals (wood) Drect labor Overhead 1 $25 per kg. 2 $20 per hour 2 labor $10 per hour $ Total cost $85 overhead at the rate of $10 per labor hour. The standard costs of drect materals, drect labor, and overhead for one bat are as shown n Exhbt 24.5 n what s called a standard cost card. These cost amounts are then used to prepare manufacturng budgets for a budgeted level of producton.

10 Chapter 24 Flexble Budgets and 961 Cost Varances A cost varance, also smply called a varance, s the dfference between actual and standard costs. A cost varance can be favorable or unfavorable. A varance from standard cost s consdered favorable f actual cost s less than standard cost. It s consdered unfavorable f actual cost s more than standard cost. 1 Ths secton dscusses varance analyss. Descrbe varances and C2 what they reveal about performance. Cost Varance Analyss Varances are usually dentfed n performance reports. When a varance occurs, management wants to determne the factors causng t. Ths often nvolves analyss, evaluaton, and explanaton. The results of these efforts should enable management to assgn responsblty for the varance and then to take actons to correct the stuaton. To llustrate, Optel s standard materals cost for producng 12,000 unts of ts product s $12,000. Its actual materals cost for January proved to be $13,000. The $1,000 unfavorable varance rases questons that call for answers that, n turn, can lead to changes to correct the stuaton and elmnate ths varance n the next perod. A performance report often dentfes the exstence of a problem, but we must follow up wth further nvestgaton to see what can be done to mprove future performance. Exhbt 24.6 shows the flow of events n the effectve management of varance analyss. It shows four steps: (1) preparng a standard cost performance report, (2) computng and analyzng varances, (3) dentfyng questons and ther explanatons, and (4) takng correctve and strategc actons. These varance analyss steps are nterrelated and are frequently appled n good organzatons. Cost Performance Report Standard Actual Varance Hbkvfdnvk fns; ds,d ds,d Hbkvfdnvk Hbkvfdnvk fns; fns; ds,d ds,d Hbkvfdnvk fns; ds,d ds,d sjblv skb0l skb0l cghs s k sjblv skb0l skb0l cghs s k sjblv skb0l skb0l cghs cghs s k kjhfv kdhac;,nchjdg kdhac;,nchjdg kjhfv kjhfv kdhac;,nchjdg kdhac;,nchjdg kjhfv kdhac;,nchjdg kdhac;,nchjdg jvkfd jvkfd hfewfj jlkjfo jlkjfo kjnv kjnv jvkfd hfewfj hfewfj jlkjfo jvkfd jvkfd hfew hfew Standard vs. Actual Prepare Reports Analyze Varances Questons and Answers Take Acton Exhbt 24.6 Varance Analyss Cost Varance Computaton Management needs nformaton about the factors causng a cost varance, but frst t must properly compute the varance. In ts most smple form, a cost varance (CV) s computed as the dfference between actual cost (AC) and standard cost (SC) as shown n Exhbt Cost Varance (CV) Actual Cost (AC) Standard Cost (SC) where: Actual Cost (AC) Actual Quantty (AQ) Actual Prce (AP) Standard Cost (SC) Standard Quantty (SQ) Standard Prce (SP) Exhbt 24.7 Cost Varance Formulas A cost varance s further defned by ts components. Actual quantty (AQ) s the nput (materal or labor) used to manufacture the quantty of output. Standard quantty (SQ) s the expected nput for the quantty of output. Actual prce (AP) s the amount pad to acqure the nput (materal or labor), and standard prce (SP) s the expected prce. 1 Short-term favorable varances can sometmes lead to long-term unfavorable varances. For nstance, f management spends less than the budgeted amount on mantenance or nsurance, the performance report would show a favorable varance. Cuttng these expenses can lead to major losses n the long run f machnery wears out prematurely or nsurance coverage proves nadequate.

11 962 Chapter 24 Flexble Budgets and Pont: Prce and quantty varances for drect labor are nearly always referred to as rate and effcency varances, respectvely. Two man factors cause a cost varance: (1) the dfference between actual prce and standard prce results n a prce (or rate) varance and (2) the dfference between actual quantty and standard quantty results n a quantty (or usage or effcency) varance. To assess the mpacts of these two factors on a cost varance, we use the formula n Exhbt Exhbt 24.8 Prce Varance and Quantty Varance Formulas Actual Cost Standard Cost AQ AP AQ SP SQ SP Prce Varance Quantty Varance Cost Varance These formulas dentfy the sources of the cost varance. Managers sometmes fnd t useful to apply an alternatve (but equvalent) computaton for the prce and quantty varances as shown n Exhbt Exhbt 24.9 Alternatve Prce Varance and Quantty Varance Formulas Prce Varance (PV) [Actual Prce (AP) Standard Prce (SP)] Actual Quantty (AQ) Quantty Varance (QV) [Actual Quantty (AQ) Standard Quantty (SQ)] Standard Prce (SP) The results from applyng the formulas n Exhbts 24.8 and 24.9 are dentcal. P2 Compute materals and labor varances. Materals and Labor Varances We llustrate the computaton of the materals and labor cost varances usng data from G-Max, a company that makes specalty golf equpment and accessores for ndvdual customers. Ths company has set the followng standard quanttes and prces for materals and labor per unt for one of ts hand-crafted golf clubheads: Drect materals (1 lb. per unt at $1 per lb.) $1.00 Drect labor (1 hr. per unt at $8 per hr.) Total standard drect cost per unt $9.00 Materals Cost Varances Durng May 2008, G-Max budgeted to produce 4,000 clubheads (unts). It actually produced only 3,500 unts. It used 3,600 pounds of drect materals (ttanum) costng $1.05 per pound, meanng ts total materals cost was $3,780. Ths nformaton allows us to compute both actual and standard drect materals costs for G-Max s 3,500 unts and ts drect materals cost varance as follows: Topc Tackler 24-2 PLUS Actual cost ,600 $1.05 per lb. $3,780 Standard cost ,500 $1.00 per lb. 3,500 Drect materals cost varance (unfavorable) $ 280

12 Chapter 24 Flexble Budgets and 963 The materals prce and quantty varances for these G-Max clubheads are computed and shown n Exhbt Actual Cost Standard Cost AQ AP AQ SP SQ SP 3,600 lbs. $1.05 3,600 lbs. $1.00 3,500 lbs. $1.00 $3,780 $3,600 $3,500 Exhbt Materals Prce and Quantty Varances $180 U $100 U Prce Varance Quantty Varance $280 U Total Drect Materals Varance The $180 unfavorable prce varance results from payng 5 cents more than the standard prce, computed as 3,600 lbs. $0.05. The $100 unfavorable quantty varance s due to usng 100 lbs. more materals than the standard quantty, computed as 100 lbs. $1. The total drect materals varance s $280 and s unfavorable. Ths nformaton allows management to ask the responsble ndvduals for explanatons and correctve actons. The purchasng department s usually responsble for the prce pad for materals. Responsblty for explanng the prce varance n ths case rests wth the purchasng manager f a prce hgher than standard caused the varance. The producton department s usually responsble for the amount of materal used and n ths case s responsble for explanng why the process used more than the standard amount of materals. Varance analyss presents challenges. For nstance, the producton department could have used more than the standard amount of materal because ts qualty dd not meet specfcatons and led to excessve waste. In ths case, the purchasng manager s responsble for explanng why nferor materals were acqured. However, the producton manager s responsble for explanng what happened f analyss shows that waste was due to neffcences, not poor qualty materal. In evaluatng prce varances, managers must recognze that a favorable prce varance can ndcate a problem wth poor product qualty. Redhook Ale, a mcro brewery n the Pacfc Northwest, can probably save 10% to 15% n materal prces by buyng sx-row barley malt nstead of the better two-row from Washngton s Yakma valley. Attenton to qualty, however, has helped Redhook Ale become the only craft brewer to be kosher certfed. Redhook s purchasng actvtes are judged on both the qualty of the materals and the purchase prce varance. Ths stand on qualty has helped Redhook report ncreases n both sales and gross margn. Example: Identfy at least two factors that mght have caused the $100 unfavorable quantty varance and the $180 unfavorable prce varance n Exhbt Answer: Poor qualty materals or untraned workers for the former; poor prce negotaton or hgher qualty materals for the latter. Example: Gve an example of a manufacturng stuaton n whch a favorable prce varance for materal mght be the cause of an unfavorable quantty varance. Answer: Buyng cheap materals. Labor Cost Varances Labor cost for a specfc product or servce depends on the number of hours worked (quantty) and the wage rate pad to employees (prce). When actual amounts for a task dffer from standard, the labor cost varance can be dvded nto a rate (prce) varance and an effcency (quantty) varance. To llustrate, G-Max s drect labor standard for 3,500 unts of ts hand-crafted clubheads s one hour per unt, or 3,500 hours at $8 per hour. Snce only 3,400 hours at $8.30 per hour were actually used to complete the unts, the actual and standard labor costs are Actual cost ,400 $8.30 per hr. $28,220 Standard cost ,500 $8.00 per hr. 28,000 Drect labor cost varance (unfavorable) $ 220

13 964 Chapter 24 Flexble Budgets and Exhbt Labor Rate and Effcency Varances* Ths analyss shows that actual cost s merely $220 over the standard and suggests no mmedate concern. Computng both the labor rate and effcency varances reveals a dfferent pcture, however, as shown n Exhbt Actual Cost Standard Cost AH AR AH SR SH SR 3,400 hrs. $8.30 3,400 hrs. $8.00 3,500 hrs. $8.00 $28,220 $27,200 $28,000 $1,020 U $800 F Rate Varance Effcency Varance $220 U Total Drect Labor Varance Example: Compute the rate varance and the effcency varance for Exhbt f 3,700 actual hours are used at an actual prce of $7.50 per hour. Answer: $1,850 favorable labor rate varance and $1,600 unfavorable labor effcency varance. * AH s actual drect labor hours: AR s actual wage rate; SH s standard drect labor hours allowed for actual output; SR s standard wage rate. The analyss n Exhbt shows that an $800 favorable effcency varance results from usng 100 fewer drect labor hours than standard for the unts produced, but ths favorable varance s more than offset by a wage rate that s $0.30 hgher than standard. The personnel admnstrator or possbly the producton manager needs to explan why the wage rate s hgher than expected. The producton manager should also explan how the labor hours were reduced. If ths experence can be repeated and transferred to other departments, more savngs are possble. One possble explanaton of these labor rate and effcency varances s the use of workers wth dfferent skll levels. If ths s the reason, senor management must dscuss the mplcatons wth the producton manager who has the responsblty to assgn workers to tasks wth the approprate skll level. In ths case, an nvestgaton mght show that hgher sklled workers were used to produce 3,500 unts of handcrafted clubheads. As a result, fewer labor hours Decson Maker Answer p. 978 Human Resource Manager You receve the manufacturng varance report for June and dscover a large unfavorable labor effcency (quantty) varance. What factors do you nvestgate to dentfy ts possble causes? Quck Check 5. A standard cost (a) changes n drect proporton to changes n the level of actvty, (b) s an amount ncurred at the actual level of producton for the perod, or (c) s an amount ncurred under normal condtons to provde a product or servce. 6. What s a cost varance? 7. The followng nformaton s avalable for York Company. Actual drect labor hours per unt hours Standard drect labor hours per unt hours Actual producton (unts) ,500 unts Budgeted producton (unts) ,000 unts Actual rate per hour $3.10 Standard rate per hour $3.00 mght be requred for the work, but the wage rate pad these workers s hgher than standard because of ther greater sklls. The effect of ths strategy s a hgher than standard total cost, whch would requre actons to remedy the stuaton or adjust the standard. Answers p. 978 The labor effcency varance s (a) $3,750 U, (b) $3,750 F, or (c) $3,875 U. 8. Refer to Quck Check 7; the labor rate varance s (a) $625 F or (b) $625 U. 9. If a materals quantty varance s favorable and a materals prce varance s unfavorable, can the total materals cost varance be favorable?

14 Chapter 24 Flexble Budgets and 965 Overhead Standards and Varances When standard costs are used, a predetermned overhead rate s used to assgn standard overhead costs to products or servces produced. Ths predetermned rate s often based on some overhead allocaton base (such as standard labor cost, standard labor hours, or standard machne hours). Settng Overhead Standards Standard overhead costs are the amounts expected to occur at a certan actvty level. Unlke drect materals and drect labor, overhead ncludes fxed costs and varable costs. Ths results n the average overhead cost per unt changng as the predcted volume changes. Snce standard costs are also budgeted costs, they must be establshed before the reportng perod begns. Standard overhead costs are therefore average per unt costs based on the predcted actvty level. To establsh the standard overhead cost rate, management uses the same cost structure t used to construct a flexble budget at the end of a perod. Ths cost structure dentfes the dfferent overhead cost components and classfes them as varable or fxed. To get the standard overhead rate, management selects a level of actvty (volume) and predcts total overhead cost. It then dvdes ths total by the allocaton base to get the standard rate. Standard drect labor hours expected to be used to produce the predcted volume s a common allocaton base and s used n ths secton. To llustrate, Exhbt shows the overhead cost structure used to develop G-Max s flexble overhead budgets for May The predetermned standard overhead rate for May s set before the month begns. The frst two number columns lst the per unt amounts of varable costs and the monthly amounts of fxed costs. The four rght-most columns show the costs expected to occur at four dfferent levels of actvty. The predetermned overhead rate per labor hour s smaller as volume of actvty ncreases because fxed costs reman constant. G-Max managers predcted an 80% actvty level for May, or a producton volume of 4,000 clubheads. At ths volume, they budget $8,000 as the May total overhead. Ths choce mples a $2 per unt (labor hour) average overhead cost ($8,000 4,000 unts). Snce G-Max has a standard of one drect labor hour per unt, the predetermned standard overhead rate for May s $2 per standard drect labor hour. The varable overhead rate remans constant at $1 per drect labor hour regardless of the budgeted producton level. The fxed overhead rate changes accordng to the budgeted producton volume. For nstance, for the predcted level of 4,000 unts of producton, the fxed rate s $1 per hour ($4,000 fxed costs 4,000 unts). For a producton level of 5,000 unts, however, the fxed rate s $0.80 per hour. When choosng the predcted actvty level, management consders many factors. The level can be set as hgh as 100% of capacty, but ths s rare. Factors causng the actvty level to be less than full capacty nclude dffcultes n schedulng work, equpment under repar or mantenance, and nsuffcent product demand. Good long-run management practces often call for some plant capacty n excess of current operatng needs to allow for specal opportuntes and demand changes. Decson Insght Measurng Up In the sprt of contnuous mprovement, compettors compare ther processes and performance standards aganst benchmarks establshed by ndustry leaders. Those that use benchmarkng nclude Precson Lube, Jffy Lube, All Tune and Lube, and Speedee Ol Change and Tune-Up. Pont: Managers consder the types of overhead costs when choosng the bass for assgnng overhead costs to products. Pont: Varable costs per unt reman constant, but fxed costs per unt declne wth ncreases n volume. Ths means the average total overhead cost per unt declnes wth ncreases n volume.

15 966 Chapter 24 Flexble Budgets and Exhbt Flexble Overhead Budgets G-MAX Flexble Overhead Budgets For Month Ended May 31, 2008 Flexble Budget Flexble Flexble Flexble Flexble Varable Total Budget Budget Budget Budget Amount Fxed at 70% at 80% at 90% at 100% per Unt Cost Capacty Capacty Capacty Capacty Producton (n unts) unt 3,500 4,000 4,500 5,000 Factory overhead Varable costs Indrect labor $0.40/unt $1,400 $1,600 $1,800 $2,000 Indrect materals /unt 1,050 1,200 1,350 1,500 Power and lghts /unt ,000 Mantenance /unt Total varable overhead costs $1.00/unt 3,500 4,000 4,500 5,000 Fxed costs (per month) Buldng rent $1,000 1,000 1,000 1,000 1,000 Deprecaton Machnery ,200 1,200 1,200 1,200 1,200 Supervsory salares ,800 1,800 1,800 1,800 1,800 Total fxed overhead costs $4,000 4,000 4,000 4,000 4,000 Total factory overhead $7,500 $8,000 $8,500 $9,000 Standard drect labor hours hr./unt 3,500 hrs. 4,000 hrs. 4,500 hrs. 5,000 hrs. Predetermned overhead rate per standard drect labor hour $ 2.14 $ 2.00 $ 1.89 $ 1.80 P3 Compute overhead varances. Exhbt Overhead Cost Varance Usng Overhead Cost Varance Analyss When standard costs are used, the cost accountng system apples overhead to the good unts produced usng the predetermned standard overhead rate. At perod-end, the dfference between the total overhead cost appled to products and the total overhead cost actually ncurred s called an overhead cost varance, whch s defned n Exhbt Overhead cost varance (OCV) Actual overhead ncurred (AOI) Standard overhead appled (SOA) To help dentfy factors causng the overhead cost varance, managers analyze ths varance separately for varable and fxed overhead. The results provde nformaton useful for takng strategc actons to mprove company performance. Smlar to analyss of drect materals and drect labor varances, both the varable and fxed overhead varances can be separated nto useful components as shown n Exhbt A spendng varance occurs when management pays an amount dfferent than the standard prce to acqure an tem. For nstance, the actual wage rate pad to ndrect labor mght be hgher than the standard rate. Smlarly, actual supervsory salares mght be dfferent than expected. Spendng varances such as these cause management to nvestgate the reasons that the amount pad dffers from the standard. Both varable and fxed overhead costs can yeld ther own spendng varances. Analyzng varable overhead ncludes computng an effcency varance, whch occurs when standard drect labor hours (the allocaton base) expected for actual producton dffer from the actual drect labor hours used. Ths effcency

16 Chapter 24 Flexble Budgets and 967 Varable Overhead Varance* Actual Overhead Appled Overhead AH AVR AH SVR SH SVR Exhbt Varable and Fxed Overhead Varances Spendng Varance Effcency Varance Varable Overhead Varance * AH actual drect labor hours; AVR actual varable overhead rate; SH standard drect labor hours; SVR standard varable overhead rate. Fxed Overhead Varance Actual Overhead Budgeted Overhead Appled Overhead Spendng Varance Volume Varance Fxed Overhead Varance varance reflects on the cost-effectveness n usng the overhead allocaton base (such as drect labor). A volume varance occurs when a dfference occurs between the actual volume of producton and the standard volume of producton. The budgeted fxed overhead amount s the same regardless of the volume of producton (wthn the relevant range). Ths budgeted amount s computed based on standard drect labor hours that the budgeted producton volume allows. The appled overhead s based, however, on the standard drect labor hours allowed for the actual volume of producton. A dfference between budgeted and actual producton volumes results n a dfference n the standard drect labor hours allowed for these two producton levels. Ths stuaton yelds a volume varance dfferent from zero. We can combne the varable overhead spendng varance, the fxed overhead spendng varance, and the varable overhead effcency varance to get controllable varance; see Exhbt The controllable varance s so named because t refers to actvtes usually under management control. Spendng Varance Varable Overhead Varance Total Overhead Varance Effcency Varance Controllable Varance Spendng Varance Fxed Overhead Varance Volume Varance Exhbt Framework for Understandng Total Overhead Varance Computng Overhead Cost Varances To llustrate how to compute overhead cost varances, return to the G-Max data. We know that t actually produced 3,500 unts when 4,000 unts were budgeted. Addtonal G-Max data show that actual overhead cost ncurred s $7,650 (varable porton of $3,650; fxed porton of $4,000). Usng ths nformaton, we can compute overhead varances for both varable and fxed overhead. Varable Overhead Cost Varances Recall that G-Max apples overhead based on drect labor hours as the allocaton base. We know that t used 3,400 drect labor hours to produce 3,500 unts. Ths compares favorably to the standard requrement of 3,500 drect labor

17 968 Chapter 24 Flexble Budgets and hours at one labor hour per unt. We compute and separate G-Max s varable overhead cost varances as shown n Exhbt Exhbt Computng Varable Overhead Cost Varances Actual Overhead Appled Overhead AH AVR AH SVR SH SVR Gven 3,400 hrs. $1.00 3,500 hrs. $1.00 $3,650 $3,400 $3,500 $250 U $100 F Spendng Varance Effcency Varance $150 U Varable Overhead Varance The $3,650 actual varable overhead from G-Max s cost records s used to compute the actual varable overhead rate of $1.07 per drect labor hour ($3,650 3,400 drect labor hours). Ths reveals that, on average, G-Max ncurred $0.07 more per drect labor hour n varable overhead than the standard rate. The mddle column of Exhbt s computed by multplyng the 3,400 actual drect labor hours by the $1 standard rate per drect labor hour. The appled overhead s computed by multplyng the 3,500 standard hours allowed for actual producton by the $1 standard rate per drect labor hour. Fxed Overhead Cost Varances G-Max reports that t ncurred $4,000 n actual fxed overhead; ths amount equals the budgeted fxed overhead for May (see Exhbt 24.12). G-Max s budgeted fxed overhead applcaton rate s $1 per hour ($4,000 4,000 drect labor hours), but the actual producton level s only 3,500 unts. Usng ths nformaton, we can compute the fxed overhead cost varances shown n Exhbt The appled fxed overhead s computed by multplyng 3,500 standard hours allowed for the actual producton by the $1 fxed overhead allocaton rate. Exhbt reveals that the fxed overhead spendng varance s zero and the volume varance s $500. The volume varance occurs because 500 fewer unts are produced than budgeted; namely, 80% of the manufacturng capacty s budgeted but only 70% s used. Exhbt Computng Fxed Overhead Cost Varances Actual Overhead Budgeted Overhead Appled Overhead Gven Gven 3,500 hrs. $1.00 $4,000 $4,000 $3,500 $0 $500 U Spendng Varance Volume Varance $500 U Fxed Overhead Varance We show ths volume varance graphcally n Exhbt The upward-slopng lne reflects the amount of fxed overhead costs appled to the unts produced n May usng the predetermned fxed overhead rate. The uppermost horzontal lne reflects the $4,000 of total fxed costs budgeted for May. These two lnes cross at the planned operatng volume of 4,000 unts. When unt volume s 3,500 unts, the overhead-costs-appled lne falls $500 below the budgeted fxed overhead lne. Ths shortfall s the volume varance. An unfavorable volume varance mples that the company dd not reach ts predcted operatng level. Management needs to know why the actual level of performance dffers from the

18 Chapter 24 Flexble Budgets and 969 Costs $5,000 4,000 3,000 2,000 1,000 0 Budgeted Fxed Overhead Costs for May = $4,000 Overhead Volume Varance for May ($500) Overhead Costs Appled for May = $3,500 Dfference between Actual and Expected Producton for May (500 unts) 0 1,000 2,000 3,000 4,000 5,000 Exhbt Fxed Overhead Volume Varance Overhead Costs Appled Usng $1 per Unt Predetermned Fxed Overhead Rate Volume (unts) Actual Volume (3,500 unts) Budgeted Volume (4,000 unts) expected level. The man purpose of the volume varance s to dentfy what porton of the total varance s caused by falng to meet the expected volume level. Ths nformaton permts management to focus on the controllable varance. A complete overhead varance report provdes managers nformaton about specfc overhead costs and how they dffer from budgeted amounts. Exhbt shows G-Max s overhead varance report for May. It reveals that (1) fxed costs and mantenance cost were ncurred as expected, (2) costs for ndrect labor and power and lghts were hgher than expected, and (3) ndrect materals cost was less than expected. Usng nformaton from Exhbts and 24.17, we can compute the total controllable overhead varance as $150 unfavorable ($250 U $100 F $0). Ths amount s also readly G-MAX Overhead Varance Report For Month Ended May 31, 2008 Exhbt Overhead Varance Report Volume Varance Expected producton level Producton level acheved Volume varance % of capacty 70% of capacty $500 (unfavorable) Flexble Actual Controllable Varance Budget Results Varances* Varable overhead costs Indrect labor $1,400 $1,525 $125 U Indrect materals ,050 1, F Power and lghts U Mantenance Total varable overhead costs ,500 3, U Fxed overhead costs Buldng rent ,000 1,000 0 Deprecaton Machnery ,200 1,200 0 Supervsory salares ,800 1,800 0 Total fxed overhead costs ,000 4,000 0 Total overhead costs $7,500 $7,650 $150 U * F Favorable varance; and U Unfavorable varance. Total varable overhead (spendng and effcency) varance. Fxed overhead spendng varance.

19 970 Chapter 24 Flexble Budgets and avalable from Exhbt The overhead varance report shows the total volume varance as $500 unfavorable (shown at the top) and the $150 unfavorable controllable varance. The sum of the controllable varance and the volume varance equals the total (fxed and varable) overhead varance of $650 unfavorable. Extensons of Explan how standard C3 cost nformaton s useful for management by excepton. Ths secton extends the applcaton of standard costs for control purposes, for servce companes, and for accountng systems. for Control To control busness actvtes, top management must be able to affect the actons of lower-level managers responsble for the company s revenues and costs. After preparng a budget and establshng standard costs, management should take actons to gan control when actual costs dffer from standard or budgeted amounts. Reports such as the ones llustrated n ths chapter call management s attenton to varances from busness plans and other standards. When managers use these reports to focus on problem areas, the budgetng process contrbutes to the control functon. In usng budgeted performance reports, practce of management by Decson Ethcs Answer p. 978 Internal Audtor You dscover a manager who always spends exactly what s budgeted. About 30% of her budget s spent just before the perod-end. She admts to spendng what s budgeted, whether or not t s needed. She offers three reasons: (1) she doesn t want her budget cut, (2) management by excepton focuses on budget devatons; and (3) she beleves the money s budgeted to be spent.what acton do you take? Decson Insght Health Budget Medcal professonals contnue to struggle wth busness realtes. Qualty medcal servce s paramount, but effcency n provdng that servce also s mportant. The use of budgetng and standard costng s touted as an effectve means to control and montor medcal costs, especally overhead. for Servces excepton s often useful. Management by excepton means that managers focus attenton on the most sgnfcant varances and gve less attenton to areas where performance s reasonably close to the standard. Ths practce leads management to concentrate on the exceptonal or rregular stuatons. Management by excepton s especally useful when drected at controllable tems. Many managers use standard costs and varance analyss to nvestgate manufacturng costs. Many managers also recognze that standard costs and varances can help them control non manufacturng costs. Companes provdng servces nstead of products can beneft from the use of standard costs. Applcaton of standard costs Standard Cost Accountng System and varances can be readly adapted to nonmanufacturng stuatons. To llustrate, many servce provders use standard costs to help control expenses. Frst, they use standard costs as a bass for budgetng all servces. Second, they use perodc performance reports to compare actual results to standards. Thrd, they use these reports to dentfy sgnfcant varances wthn specfc areas of responsblty. Fourth, they mplement the approprate control procedures. We have shown how companes use standard costs n management reports. Most standard cost systems also record these costs and varances n accounts. Ths practce smplfes recordkeepng and helps n preparng reports. Although we do not need knowledge of standard cost accountng practces to understand standard costs and ther use, we must know

20 Chapter 24 Flexble Budgets and 971 how to nterpret the accounts n whch standard costs and varances are recorded. The entres n ths secton brefly llustrate the mportant aspects of ths process for G-Max s standard costs and varances for May. The frst of these entres records standard materals cost ncurred n May n the Goods n Process Inventory account. Ths part of the entry s smlar to the usual accountng entry, but the amount of the debt equals the standard cost ($3,500) nstead of the actual cost ($3,780). Ths entry credts Raw Materals Inventory for actual cost. The dfference between standard and actual costs s recorded wth debts to two separate materals varance accounts (recall Exhbt 24.10). Both the materals prce and quantty varances are recorded as debts because they reflect addtonal costs hgher than the standard cost (f actual costs were less than the standard, they are recorded as credts). Ths treatment (debt) reflects ther unfavorable effect because they represent hgher costs and lower ncome. Prepare journal entres P4 for standard costs and account for prce and quantty varances. May 31 Goods n Process Inventory ,500 Drect Materals Prce Varance* Drect Materals Quantty Varance Raw Materals Inventory ,780 To charge producton for standard quantty of materals used (3,500 lbs.) at the standard prce ($1 per lb.), and to record materal prce and materal quantty varances. Assets Labltes Equty 3, , * Many companes record the materals prce varance when materals are purchased. For smplcty, we record both the materals prce and quantty varances when materals are ssued to producton. The second entry debts Goods n Process Inventory for the standard labor cost of the goods manufactured durng May ($28,000). Actual labor cost ($28,220) s recorded wth a credt to the Factory Payroll account. The dfference between standard and actual labor costs s explaned by two varances (see Exhbt 24.11). The drect labor rate varance s unfavorable and s debted to that account. The drect labor effcency varance s favorable and s credted. The drect labor effcency varance s favorable because t represents a lower cost and a hgher net ncome. May 31 Goods n Process Inventory ,000 Drect Labor Rate Varance ,020 Drect Labor Effcency Varance Factory Payroll ,220 To charge producton wth 3,500 standard hours of drect labor at the standard $8 per hour rate, and to record the labor rate and effcency varances. Assets Labltes Equty 28,000 28,220 1, The entry to assgn standard predetermned overhead to the cost of goods manufactured must debt the $7,000 predetermned amount to the Goods n Process Inventory account. The $7,650 actual overhead costs are debted to the Factory Overhead account. Thus, when Factory Overhead s appled to Goods n Process Inventory, the amount appled s debted to the Goods n Process Inventory account and credted to the Factory Overhead account. To account for the dfference between actual and standard costs, the entry ncludes a $250 debt to the Varable Overhead Spendng Varance, a $100 credt to the Varable Overhead Effcency Varance, and a $500 debt to the Volume Varance (recall Exhbts and 24.17). An alternatve (smpler) approach, shown here, s to record the dfference wth a $150 debt to the Controllable Varance account and a $500 debt to the Volume Varance account (recall from Exhbt that controllable varance s the sum of both varable overhead varances and the fxed overhead spendng varance).

21 972 Chapter 24 Flexble Budgets and Assets Labltes Equty 7,000 7, May 31 Goods n Process Inventory ,000 Controllable Varance Volume Varance Factory Overhead ,650 To apply overhead at the standard rate of $2 per standard drect labor hour (3,500 hours), and to record overhead varances. The balances of these sx dfferent varance accounts accumulate untl the end of the accountng perod. As a result, the unfavorable varances of some months offset the favorable varances of others. These varance account balances, whch reflect results of the perod s varous transactons and events, are closed at perod-end. If the varances are materal, they are added to or subtracted from the balances of the Goods n Process Inventory, the Fnshed Goods Inventory, and the Cost of Goods Sold accounts. If the amounts are mmateral, they are added to or subtracted from the balance of the Cost of Goods Sold account. Ths process s smlar to that shown n Chapter 19 for elmnatng an underappled or overappled balance n the Factory Overhead account. (Note: These varance balances, whch represent dfferences between actual and standard costs, must be added to or subtracted from the materals, labor, and overhead costs recorded. In ths way, the recorded costs equal the actual costs ncurred n the perod; a company must use actual costs n external fnancal statements prepared n accordance wth generally accepted accountng prncples.) Quck Check 10. Under what condtons s an overhead volume varance consdered favorable? 11. To use management by excepton wth standard costs, a company (a) must record standard costs n ts accountng, (b) should compute varances from flexble budget amounts to allow management to focus ts attenton on sgnfcant dfferences between actual and budgeted results, or (c) should analyze only varances for drect materals and drect labor. 12. A company uses a standard cost accountng system. Prepare the journal entry to record these drect materals varances: Drect materals cost actually ncurred $73,200 Drect materals quantty varance (favorable) ,800 Drect materals prce varance (unfavorable) ,300 Answers p If standard costs are recorded n the manufacturng accounts, how are recorded varances treated at the end of an accountng perod? Decson Analyss Analyze changes n A2 sales from expected amounts. Sales Varances Ths chapter explaned the computaton and analyss of cost varances. A smlar varance analyss can be appled to sales. To llustrate, consder the followng sales data from G-Max for two of ts golf products, Excel golf balls and Bg Bert drvers. Budgeted Actual Sales of Excel golf balls (unts) ,000 unts 1,100 unts Sales prce per Excel golf ball $ 10 $ Sales of Bg Bert drvers (unts) unts 140 unts Sales prce per Bg Bert drver $ 200 $ 190

22 Chapter 24 Flexble Budgets and 973 Usng ths nformaton, we compute both the sales prce varance and the sales volume varance as shown n Exhbt The total sales prce varance s $850 unfavorable, and the total sales volume varance s $1,000 unfavorable. Nether varance mples anythng postve about these two products. Further analyss of these total sales varances reveals that both the sales prce and sales volume varances for Excel golf balls are favorable, meanng that both the unfavorable total sales prce varance and the unfavorable total sales volume varance are due to the Bg Bert drver. Excel Golf Balls Actual Results Flexble Budget Fxed Budget Sales unts (balls) 1,100 1,100 1,000 Sales dollars (balls) $11,550 $11,000 $10,000 Exhbt Computng Sales Varances $550 F $1,000 F Sales Prce Varance Sales Volume Varance Bg Bert Drvers Sales unts (drvers) Sales dollars (drvers) $26,600 $28,000 $30,000 $1,400 U $2,000 U Sales Prce Varance Sales Volume Varance Total $850 U $1,000 U Managers use sales varances for plannng and control purposes. The sales varance nformaton s used to plan future actons to avod unfavorable varances. G-Max sold 90 total combned unts (both balls and drvers) more than planned, but these 90 unts were not sold n the proporton budgeted. G- Max sold fewer than the budgeted quantty of the hgher prced drver, whch contrbuted to the unfavorable total sales varances. Managers use such detal to queston what caused the company to sell more golf balls and fewer drvers. Managers also use ths nformaton to evaluate and even reward ther salespeople. Extra compensaton s pad to salespeople who contrbute to a hgher proft margn. Fnally, wth multple products, the sales volume varance can be separated nto a sales mx varance and a sales quantty varance. The sales mx varance s the dfference between the actual and budgeted sales mx of the products. The sales quantty varance s the dfference between the total actual and total budgeted quantty of unts sold. Decson Maker Answer p. 978 Sales Manager The current performance report reveals a large favorable sales volume varance but an unfavorable sales prce varance.you dd not expect to see a large ncrease n sales volume.what steps do you take to analyze ths stuaton? Demonstraton Problem Pacfc Company provdes the followng nformaton about ts budgeted and actual results for June Although the expected June volume was 25,000 unts produced and sold, the company actually produced and sold 27,000 unts as detaled here: Budget Actual (25,000 unts) (27,000 unts) Sellng prce $5.00 per unt $5.23 per unt Varable costs (per unt) Drect materals per unt 1.12 per unt Drect labor per unt 1.40 per unt Factory supples* per unt 0.37 per unt Utltes* per unt 0.60 per unt Sellng costs per unt 0.34 per unt [contnued on next page]

23 974 Chapter 24 Flexble Budgets and [contnued from prevous page] Fxed costs (per month) Deprecaton Machnery* $3,750 $3,710 Deprecaton Buldng* ,500 2,500 General lablty nsurance ,200 1,250 Property taxes on offce equpment Other admnstratve expense * Indcates factory overhead tem; $0.75 per unt or $3 per drect labor hour for varable overhead, and $0.25 per unt or $1 per drect labor hour for fxed overhead. Standard costs based on expected output of 25,000 unts Per Unt Quantty Total of Output to Be Used Cost Drect materals, 4 $0.31/oz $1.24/unt 100,000 oz. $31,000 Drect labor, 0.25 $6.00/hr /unt 6,250 hrs. 37,500 Overhead /unt 25,000 Actual costs ncurred to produce 27,000 unts Per Unt Quantty Total of Output Used Cost Drect materals, 4 $0.28/oz $1.12/unt 108,000 oz. $30,240 Drect labor, 0.20 $7.00/hr /unt 5,400 hrs. 37,800 Overhead /unt 32,400 Standard costs based on expected output of 27,000 unts Per Unt Quantty Total of Output to Be Used Cost Drect materals, 4 $0.31/oz $1.24/unt 108,000 oz. $33,480 Drect labor, 0.25 $6.00/hr /unt 6,750 hrs. 40,500 Overhead ,500 Requred 1. Prepare June flexble budgets showng expected sales, costs, and net ncome assumng 20,000, 25,000, and 30,000 unts of output produced and sold. 2. Prepare a flexble budget performance report that compares actual results wth the amounts budgeted f the actual volume had been expected. 3. Apply varance analyss for drect materals, for drect labor, and for overhead. Plannng the Soluton Prepare a table showng the expected results at the three specfed levels of output. Compute the varable costs by multplyng the per unt varable costs by the expected volumes. Include fxed costs at the gven amounts. Combne the amounts n the table to show total varable costs, contrbuton margn, total fxed costs, and ncome from operatons. Prepare a table showng the actual results and the amounts that should be ncurred at 27,000 unts. Show any dfferences n the thrd column and label them wth an F for favorable f they ncrease ncome or a U for unfavorable f they decrease ncome. Usng the chapter s format, compute these total varances and the ndvdual varances requested: Total materals varance (ncludng the drect materals quantty varance and the drect materals prce varance).

24 Chapter 24 Flexble Budgets and 975 Total drect labor varance (ncludng the drect labor effcency varance and rate varance). Total overhead varance (ncludng both varable and fxed overhead varances and ther component varances). Soluton to Demonstraton Problem 1. PACIFIC COMPANY Flexble Budgets For Month Ended June 30, 2008 Flexble Budget Flexble Flexble Flexble Budget Budget Budget Varable Total for Unt for Unt for Unt Amount Fxed Sales of Sales of Sales of per Unt Cost 20,000 25,000 30,000 Sales $5.00 $100,000 $125,000 $150,000 Varable costs Drect materals ,800 31,000 37,200 Drect labor ,000 37,500 45,000 Factory supples ,000 6,250 7,500 Utltes ,000 12,500 15,000 Sellng costs ,000 10,000 12,000 Total varable costs ,800 97, ,700 Contrbuton margn $ ,200 27,750 33,300 Fxed costs Deprecaton Machnery $3,750 3,750 3,750 3,750 Deprecaton Buldng ,500 2,500 2,500 2,500 General lablty nsurance ,200 1,200 1,200 1,200 Property taxes on offce equpment Other admnstratve expense Total fxed costs $8,700 8,700 8,700 8,700 Income from operatons $ 13,500 $ 19,050 $ 24, PACIFIC COMPANY Flexble Budget Performance Report For Month Ended June 30, 2008 Flexble Actual Budget Results Varance* Sales (27,000 unts) $135,000 $141,210 $6,210 F Varable costs Drect materals ,480 30,240 3,240 F Drect labor ,500 37,800 2,700 F Factory supples ,750 9,990 3,240 U Utltes ,500 16,200 2,700 U Sellng costs ,800 9,180 1,620 F Total varable costs , ,410 1,620 F Contrbuton margn ,970 37,800 7,830 F Fxed costs Deprecaton Machnery ,750 3, F Deprecaton Buldng ,500 2,500 0 General lablty nsurance ,200 1, U Property taxes on offce equpment F Other admnstratve expense U Total fxed costs ,700 8, U Income from operatons $ 21,270 $ 28,955 $7,685 F * F Favorable varance; and U Unfavorable varance.

25 976 Chapter 24 Flexble Budgets and 3. Varance analyss of materals, labor, and overhead costs. Materals cost varances Actual cost ,000 $0.28 $30,240 Standard cost ,000 $ ,480 Drect materals cost varance (favorable) $ 3,240 Prce and quantty varances (based on formulas n Exhbt 24.10): Actual Cost Standard Cost AQ AP AQ SP SQ SP 108,000 oz. $ ,000 oz. $ ,000 oz. $0.31 $30,240 $33,480 $33,480 $3,240 F $0 Prce Varance Quantty Varance $3,240 F Total Drect Materals Varance Labor cost varances Actual cost ,400 $7.00 $37,800 Standard cost ,750 $ ,500 Drect labor cost varance (favorable) $ 2,700 Rate and effcency varances (based on formulas n Exhbt 24.11): Actual Cost Standard Cost AH AR AH SR SH SR 5,400 hrs. $7 5,400 hrs. $6 6,750 hrs. $6 $37,800 $32,400 $40,500 $5,400 U $8,100 F Rate Varance Effcency Varance $2,700 F Total Drect Labor Varance Overhead cost varances Total overhead cost ncurred ,000 $1.20 $32,400 Total overhead appled ,000 $ ,000 Overhead cost varance (unfavorable) $ 5,400 Varable overhead varance (factory supples and utltes) Varable overhead cost ncurred (gven) $26,190 Varable overhead cost appled ,750 $3/hr. 20,250 Varable overhead cost varance (unfavorable) $ 5,940 Spendng and effcency varances (based on formulas n Exhbt 24.14): Actual Overhead Appled Overhead AH AVR AH SVR SH SVR 5,400 $3 6,750 $3 $26,190 $16,200 $20,250 $9,990 U $4,050 F Spendng Varance Effcency Varance $5,940 U Total Varable Overhead Varance [contnued on next page]

26 Chapter 24 Flexble Budgets and 977 [contnued from prevous page] Fxed overhead (deprecaton on machnery and buldng) Fxed overhead cost ncurred (gven) $ 6,210 Fxed overhead cost appled ,750 $1/hr. 6,750 Fxed overhead cost varance (favorable) $ 540 Spendng and volume varances (based on formulas n Exhbt 24.14): Actual Overhead Budgeted Overhead Appled Overhead 6,750 $1 $6,210 $6,250 $6,750 $40 F $500 F Spendng Varance Volume Varance We can also compute Controllable varance: Volume varance: $540 F Total Fxed Overhead Varance $5,900 U (both spendng varances plus effcency varance) 500 F (dentfed as above) Summary C1 Defne standard costs and explan ther computaton and uses. Standard costs are the normal costs that should be ncurred to produce a product or perform a servce. They should be based on a careful examnaton of the processes used to produce a product or perform a servce as well as the quanttes and prces that should be ncurred n carryng out those processes. On a performance report, standard costs (whch are flexble budget amounts) are compared to actual costs, and the dfferences are presented as varances. C2 Descrbe varances and what they reveal about performance. Management can use varances to montor and control actvtes. Total cost varances can be broken nto prce and quantty varances to drect management s attenton to those responsble for quanttes used and prces pad. C3 Explan how standard cost nformaton s useful for management by excepton. Standard cost accountng provdes management nformaton about costs that dffer from budgeted (expected) amounts. Performance reports dsclose the costs or areas of operatons that have sgnfcant varances from budgeted amounts. Ths allows managers to focus attenton on the exceptons and less attenton on areas proceedng normally. A1 Compare fxed and flexble budgets. A fxed budget shows the revenues and costs expected to occur at a specfed volume level. If actual volume s at some other level, the amounts n the fxed budget do not provde a reasonable bass for evaluatng actual performance. A flexble budget expresses varable costs n per unt terms so that t can be used to develop budgeted amounts for any volume level wthn the relevant range. Thus, managers compute budgeted amounts for evaluaton after a perod for the volume that actually occurred. A2 Analyze changes n sales from expected amounts. Actual sales can dffer from budgeted sales, and managers can nves- tgate ths dfference by computng both the sales prce and sales volume varances. The sales prce varance refers to that porton of total varance resultng from a dfference between actual and budgeted sellng prces. The sales volume varance refers to that porton of total varance resultng from a dfference between actual and budgeted sales quanttes. P1 Prepare a flexble budget and nterpret a flexble budget performance report. To prepare a flexble budget, we express each varable cost as a constant amount per unt of sales (or as a percent of sales dollar). In contrast, the budgeted amount of each fxed cost s expressed as a total amount expected to occur at any sales volume wthn the relevant range. The flexble budget s then determned usng these computatons and amounts for fxed and varable costs at the expected sales volume. P2 Compute materals and labor varances. Materals and labor varances are due to dfferences between the actual costs ncurred and the budgeted costs. The prce (or rate) varance s computed by comparng the actual cost wth the flexble budget amount that should have been ncurred to acqure the actual quantty of resources. The quantty (or effcency) varance s computed by comparng the flexble budget amount that should have been ncurred to acqure the actual quantty of resources wth the flexble budget amount that should have been ncurred to acqure the standard quantty of resources. P3 Compute overhead varances. Overhead varances are due to dfferences between the actual overhead costs ncurred and the overhead appled to producton. An overhead spendng varance arses when the actual amount ncurred dffers from the budgeted amount of overhead. An overhead effcency (or volume) varance arses when the flexble overhead budget amount dffers from the overhead appled to producton. It s mportant to realze that overhead s assgned usng an overhead allocaton base, meanng that an effcency varance (n the case of varable overhead) s a result

27 978 Chapter 24 Flexble Budgets and of the overhead applcaton base beng used more or less effcently than planned. P4 Prepare journal entres for standard costs and account for prce and quantty varances. When a company records standard costs n ts accounts, the standard costs of materals, labor, and overhead are debted to the Goods n Process Inventory account. Based on an analyss of the materal, labor, and overhead costs, each quantty varance, prce varance, volume varance, and controllable varance s recorded n a separate account. At perodend, f the varances are materal, they are allocated among the balances of the Goods n Process Inventory, Fnshed Goods Inventory, and Cost of Goods Sold accounts. If they are not materal, they are smply debted or credted to the Cost of Goods Sold account. Gudance Answers to Decson Maker and Decson Ethcs Entrepreneur From the complants, ths performance report appears to compare actual results wth a fxed budget. Ths comparson s useful n determnng whether the amount of work actually performed was more or less than planned, but t s not useful n determnng whether the dvsons were more or less effcent than planned. If the two consultng dvsons worked on more assgnments than expected, some costs wll certanly ncrease. Therefore, you should prepare a flexble budget usng the actual number of consultng assgnments and then compare actual performance to the flexble budget. Human Resource Manager As HR manager, you should nvestgate the causes for any labor-related varances although you may not be responsble for them. An unfavorable labor effcency varance occurs because more labor hours than standard were used durng the perod. There are at least three possble reasons for ths: (1) materals qualty could be poor, resultng n more labor consumpton due to rework, (2) unplanned nterruptons (strke, breakdowns, accdents) could have occurred durng the perod, and (3) the producton manager could have used a dfferent labor mx to expedte orders. Ths new labor mx could have conssted of a larger proporton of untraned labor, whch resulted n more labor hours. Internal Audtor Although the manager s actons mght not be unethcal, ths acton s undesrable. The nternal audtor should report ths behavor, possbly recommendng that for the purchase of such dscretonary tems, the manager must provde budgetary requests usng an actvty-based budgetng process. The nternal audtor would then be gven full authorty to verfy ths budget request. Sales Manager The unfavorable sales prce varance suggests that actual prces were lower than budgeted prces. As the sales manager, you want to know the reasons for a lower than expected prce. Perhaps your salespeople lowered the prce of certan products by offerng quantty dscounts. You then mght want to know what prompted them to offer the quantty dscounts (perhaps compettors were offerng dscounts). You want to break the sales volume varance nto both the sales mx and sales quantty varances. You could fnd that although the sales quantty varance s favorable, the sales mx varance s not. Then you need to nvestgate why actual sales mx dffers from budgeted sales mx. Gudance Answers to Quck Checks 1. b 2. The frst step s classfyng each cost as varable or fxed. 3. A fxed budget s prepared usng an expected volume of sales or producton. A flexble budget s prepared usng the actual volume of actvty. 4. Contrbuton margn equals sales less varable costs. 5. c 6. It s the dfference between actual cost and standard cost. 7. a; Total actual hours: 2, ,250 Total standard hours: 2, ,000 Effcency varance (6,250 5,000) $3.00 $3,750 U 8. b; Rate varance ($3.10 $3.00) 6,250 $625 U 9. Yes, ths wll occur when the materals quantty varance s more than the materals prce varance. 10. The overhead volume varance s favorable when the actual operatng level s hgher than the expected level. 11. b 12. Goods n Process Inventory ,700 Drect Materals Prce Varance ,300 Drect Materals Quantty Varance ,800 Raw Materals Inventory , If the varances are materal, they should be prorated among the Goods n Process Inventory, Fnshed Goods Inventory, and Cost of Goods Sold accounts. If they are not materal, they can be closed to Cost of Goods Sold. Key Terms

28 Chapter 24 Flexble Budgets and 979 Key Terms mhhe.com/wldfap18e Key Terms are avalable at the book s Webste for learnng and testng n an onlne Flashcard Format. Budgetary control (p. 954) Budget report (p. 954) Controllable varance (p. 967) Cost varance (p. 961) Effcency varance (p. 966) Favorable varance (p. 956) Fxed budget (p. 955) Fxed budget performance report (p. 955) Flexble budget (p. 956) Flexble budget performance report (p. 958) Management by excepton (p. 970) Overhead cost varance (p. 966) Prce varance (p. 958) Quantty varance (p. 958) Spendng varance (p. 966) Standard costs (p. 959) Unfavorable varance (p. 956) Varance analyss (p. 958) Volume varance (p. 967) Multple Choce Quz Answers on p. 995 mhhe.com/wldfap18e Multple Choce Quzzes A and B are avalable at the book s Webste. 1. A company predcts ts producton and sales wll be 24,000 unts. At that level of actvty, ts fxed costs are budgeted at $300,000, and ts varable costs are budgeted at $246,000. If ts actvty level declnes to 20,000 unts, what wll be ts fxed costs and ts varable costs? a. Fxed, $300,000; Varable, $246,000 b. Fxed, $250,000; Varable, $205,000 c. Fxed, $300,000; Varable, $205,000 d. Fxed, $250,000; Varable, $246,000 e. Fxed, $300,000; Varable, $300, Usng the followng nformaton about a sngle-product company, compute ts total actual cost of drect materals used. Drect materals standard cost: 5 lbs. $2 per lb. $10. Total drect materals cost varance: $15,000 unfavorable. Actual drect materals used: 300,000 lbs. Actual unts produced: 60,000 unts. a. $585,000 b. $600,000 c. $300,000 d. $315,000 e. $615, A company uses four hours of drect labor to produce a product unt. The standard drect labor cost s $20 per hour. Ths perod the company produced 20,000 unts and used 84,160 hours of drect labor at a total cost of $1,599,040. What s ts labor rate varance for the perod? a. $83,200 F b. $84,160 U c. $84,160 F d. $83,200 U e. $ 960 F 4. A company s standard for a unt of ts sngle product s $6 per unt n varable overhead (4 hours $1.50 per hour). Actual data for the perod shows varable overhead costs of $150,000 and producton of 24,000 unts. Its total varable overhead cost varance s a. $ 6,000 F b. $ 6,000 U c. $114,000 U d. $114,000 F e. $ 0 5. A company s standard for a unt of ts sngle product s $4 per unt n fxed overhead ($24,000 total/6,000 unts budgeted). Actual data for the perod shows total actual fxed overhead of $24,100 and producton of 4,800 unts. Its volume varance s a. $4,800 U b. $4,800 F c. $ 100 U d. $ 100 F e. $4,900 U Dscusson Questons 1. What lmts the usefulness to managers of fxed budget performance reports? 2. Identfy the man purpose of a flexble budget for managers. 3. Prepare a flexble budget performance report ttle (n proper form) for Spaldng Company for the calendar year Why s a proper ttle mportant for ths or any report?

29 980 Chapter 24 Flexble Budgets and 4. What type of analyss does a flexble budget performance report help management perform? 5. In what sense can a varable cost be consdered constant? 6. What department s usually responsble for a drect labor rate varance? What department s usually responsble for a drect labor effcency varance? Explan. 7. What s a prce varance? What s a quantty varance? 8. What s the purpose of usng standard costs? 9. In an analyss of fxed overhead cost varances, what s the volume varance? 10. What s the predetermned standard overhead rate? How s t computed? 11. In general, varance analyss s sad to provde nformaton about and varances. 12. In an analyss of overhead cost varances, what s the controllable varance and what causes t? 13. What s the relaton among standard costs, flexble budgets, varance analyss, and management by excepton? 14. How can the manager of a musc department of a Best Buy retal store use flexble budgets to enhance performance? 15. Is t possble for a retal store such as Crcut Cty to use varances n analyzng ts operatng performance? Explan. 16. Assume that Apple s budgeted to operate at 80% of capacty but actually operates at 75% of capacty. What effect wll the 5% devaton have on ts controllable varance? Its volume varance? Red numbers denote Dscusson Questons that nvolve decson-makng. QUICK STUDY QS 24-1 Flexble budget performance report P1 Beech Company reports the followng selected fnancal results for May. For the level of producton acheved n May, the budgeted amounts would be: sales, $1,300,000; varable costs, $750,000; and fxed costs, $300,000. Prepare a flexble budget performance report for May. Sales (150,000 unts) $1,275,000 Varable costs ,500 Fxed costs ,000 QS 24-2 Labor cost varances C2 P2 Frontera Company s output for the current perod results n a $20,000 unfavorable drect labor rate varance and a $10,000 unfavorable drect labor effcency varance. Producton for the current perod was assgned a $400,000 standard drect labor cost. What s the actual total drect labor cost for the current perod? QS 24-3 Materals cost varances C2 P2 Juan Company s output for the current perod was assgned a $150,000 standard drect materals cost. The drect materals varances ncluded a $12,000 favorable prce varance and a $2,000 favorable quantty varance. What s the actual total drect materals cost for the current perod? QS 24-4 Materals cost varances C2 P2 For the current perod, Kayenta Company s manufacturng operatons yeld a $4,000 unfavorable prce varance on ts drect materals usage. The actual prce per pound of materal s $78; the standard prce s $ How many pounds of materal are used n the current perod? QS 24-5 Management by excepton C3 Managers use management by excepton for control purposes. (1) Descrbe the concept of management by excepton. (2) Explan how standard costs help managers apply ths concept to montor and control costs. QS 24-6 Overhead cost varances P3 Alvarez Company s output for the current perod yelds a $20,000 favorable overhead volume varance and a $60,400 unfavorable overhead controllable varance. Standard overhead charged to producton for the perod s $225,000. What s the actual total overhead cost ncurred for the perod?

30 Chapter 24 Flexble Budgets and 981 Refer to the nformaton n QS Alvarez records standard costs n ts accounts. Prepare the journal entry to charge overhead costs to the Goods n Process Inventory account and to record any varances. QS 24-7 Preparng overhead entres P4 Farad Company specalzes n sellng used SUVs. Durng the frst sx months of 2008, the dealershp sold 50 SUVs at an average prce of $9,000 each. The budget for the frst sx months of 2008 was to sell 45 SUVs at an average prce of $9,500 each. Compute the dealershp s sales prce varance and sales volume varance for the frst sx months of QS 24-8 Computng sales prce and volume varances A2 Tempo Company s fxed budget for the frst quarter of calendar year 2008 reveals the followng. Prepare flexble budgets followng the format of Exhbt 24.3 that show varable costs per unt, fxed costs, and three dfferent flexble budgets for sales volumes of 6,000, 7,000, and 8,000 unts. Sales (7,000 unts) $2,800,000 Cost of goods sold Drect materals $280,000 Drect labor ,000 Producton supples ,000 Plant manager salary ,000 1,010,000 Gross proft ,790,000 Sellng expenses Sales commssons ,000 Packagng ,000 Advertsng , ,000 Admnstratve expenses Admnstratve salares ,000 Deprecaton Offce equp ,000 Insurance ,000 Offce rent , ,000 EXERCISES Exercse 24-1 Preparaton of flexble budgets P1 Income from operatons $1,195,000 Check Income (at 6,000 unts), $972,000 JPAK Company manufactures and sells mountan bkes. It normally operates eght hours a day, fve days a week. Usng ths nformaton, classfy each of the followng costs as fxed or varable. If addtonal nformaton would affect your decson, descrbe the nformaton. a. Deprecaton on tools e. Management salares. Gas used for heatng b. Penson cost f. Incomng shppng expenses j. Drect labor c. Bke frames g. Offce supples k. Repar expense for tools d. Screws for assembly h. Taxes on property Exercse 24-2 Classfcaton of costs as fxed or varable P1 Soltare Company s fxed budget performance report for June follows. The $315,000 budgeted expenses nclude $294,000 varable expenses and $21,000 fxed expenses. Actual expenses nclude $27,000 fxed expenses. Prepare a flexble budget performance report that shows any varances between budgeted results and actual results. Lst fxed and varable expenses separately. Exercse 24-3 Preparaton of a flexble budget performance report A1 Fxed Budget Actual Results Varances Sales (n unts) ,400 10,800 Sales (n dollars) $420,000 $540,000 $120,000 F Total expenses , ,000 63,000 U Income from operatons $105,000 $162,000 $ 57,000 F Check Income varance, $21,000 F

31 982 Chapter 24 Flexble Budgets and Exercse 24-4 Preparaton of a flexble budget performance report A1 Bay Cty Company s fxed budget performance report for July follows. The $647,500 budgeted expenses nclude $487,500 varable expenses and $160,000 fxed expenses. Actual expenses nclude $158,000 fxed expenses. Prepare a flexble budget performance report showng any varances between budgeted and actual results. Lst fxed and varable expenses separately. Check Income varance, $4,000 F Fxed Budget Actual Results Varances Sales (n unts) ,500 7,200 Sales (n dollars) $750,000 $737,000 $13,000 U Total expenses , ,000 6,500 F Income from operatons $102,500 $ 96,000 $ 6,500 U Exercse 24-5 Computaton and nterpretaton of labor varances C2 P2 Check October rate varance, $3,250 U After evaluatng Null Company s manufacturng process, management decdes to establsh standards of 3 hours of drect labor per unt of product and $15 per hour for the labor rate. Durng October, the company uses 16,250 hours of drect labor at a $247,000 total cost to produce 5,600 unts of product. In November, the company uses 22,000 hours of drect labor at a $335,500 total cost to produce 6,000 unts of product. (1) Compute the rate varance, the effcency varance, and the total drect labor cost varance for each of these two months. (2) Interpret the October drect labor varances. Exercse 24-6 Computaton and nterpretaton of overhead varances C2 P3 Sedona Company set the followng standard costs for one unt of ts product for Drect materal (20 $2.50 per Ib.) $ Drect labor (10 $8.00 per hr.) Factory varable overhead (10 $4.00 per hr.) Factory fxed overhead (10 $1.60 per hr.) Standard cost $ The $5.60 ($4.00 $1.60) total overhead rate per drect labor hour s based on an expected operatng level equal to 75% of the factory s capacty of 50,000 unts per month. The followng monthly flexble budget nformaton s also avalable. Operatng Levels Budgeted output (unts) Budgeted labor (standard hours) Budgeted overhead (dollars) Varable overhead Fxed overhead Total overhead 70% 75% 80% 35, ,000 $1,400, ,000 $2,000,000 37, ,000 $1,500, ,000 $2,100,000 40, ,000 $1,600, ,000 $2,200,000 Durng the current month, the company operated at 70% of capacty, employees worked 340,000 hours, and the followng actual overhead costs are ncurred. Varable overhead costs $1,375,000 Fxed overhead costs ,600 Total overhead costs $2,003,600