Chapter 11 Standard Costs and Variance Analysis

Transcription

1 Chapter 11: Standard Costs and Variance Analysis 229 Chapter 11 Standard Costs and Variance Analysis LEARNING OBJECTIVES Chapter 11 addresses the following questions: LO1 LO2 LO3 LO4 LO5 LO6 LO7 LO8 Explain the role of variance analysis in the strategic management process. Describe a standard costing system and how it is used. Calculate and journalize direct cost variances. Analyze and use direct cost variance information. Calculate and journalize variable and fixed overhead variances. Analyze and use overhead variance information. Journalize closing entries for manufacturing cost variances. Calculate and analyze profit-related variances. (Appendix 11A) These learning questions (LO1 through LO8) are cross-referenced in the textbook to individual exercises and problems.

2 230 Cost Management QUESTIONS 11.1 Managers need information about the costs of direct materials and direct labour as well as whether direct materials and labour have been used efficiently. If the price and efficiency variances are combined, it is impossible to separate the causes of the variance into potential changes in prices of direct materials (or the labour hourly wage) and changes in the amount of materials (or labour hours) used to manufacture the product. Managers need specific information to better monitor operations and investigate changes Utilities are considered fixed costs. These include phone service, natural gas, and electricity. The use of natural gas and electricity is affected by weather patterns. Because weather patterns change, these costs cannot be perfectly predicted. There may be unanticipated price changes in the cost of utilities. In addition, employees could be careless in their use of electricity or telephones. Therefore, variances occur regularly Variances compare actual costs to budgeted or standard costs. As such, they reflect a diagnostic control system that indicates whether or not preset goals are met. Managers investigate large variances, particularly unfavorable variances, to investigate reasons why plans are not met and to consider taking corrective action GAAP requires that revenues and expenses be matched. Revenues from the sales of units must be matched to the costs of producing those same units. When a standard cost system is used, production costs are recorded at standard rather than at actual costs. At the end of the accounting period adjusting entries are made to close the variance accounts and to distribute the amounts to inventory and cost of goods sold. These entries simultaneously close the variance accounts and adjust inventory and cost of goods sold to reflect actual costs for the period For a simple but meaningful variance report for costs, the following variances should be calculated Price and efficiency variances for direct materials and direct labour provide information about price changes, purchasing efficiencies and the use of materials. Managers can correct some of these problems to insure cost-effective production. The variable overhead spending variance and the fixed overhead budget variance provide information about whether costs are being kept under control. The efficiency variance for variable overhead and production volume variances do not provide any incremental information about whether inputs were purchased or used efficiently. At the end of the accounting period, the following variances need to be recorded: direct materials and direct labour price and efficiency variances, variable overhead spending variance, fixed overhead budget variance, variable overhead efficiency variance, and production volume variance. If the sum of these is immaterial, it is closed to cost of goods sold. If the sum is material, it is prorated across inventory and COGS.

3 Chapter 11: Standard Costs and Variance Analysis Managers monitor variances that are large and unexpected. Sometimes a minimum dollar amount is set as a criteria so that only variances greater than that amount are investigated. Managers make trade-offs between the costs of investigating and the benefit from improving the process or standard. Trends in variances also may affect whether a variance is investigated. If accountants know a variance is increasing over time, they may decide to investigate to identify ways to reverse a negative trend or to modify future standards for a positive trend The cost categories that are measured and monitored in a given organization depend on several factors, including the following: 11.9 Nature of goods or services: Manufacturers monitor input prices and efficiency of labour and materials, whereas service organizations monitor cost per service provided, which may not include materials. All organizations monitor fixed costs, although the type of fixed costs varies widely with the type of business. Cost accounting system used: The cost categories will be more precise with more complex cost accounting systems. An organization with an ABC system that separates costs into flexible and committed categories could develop standards and measure variances for every activity performed. Alternatively, only broad categories may be tracked, such as the traditional direct materials and direct labour categories. Costs that managers consider important: Overhead costs are often aggregated together and include indirect costs such as oil for machine maintenance. While these costs may not be individually important, they are often monitored as part of the larger category of overhead costs. Cost/benefit trade-off for monitoring individual costs: For those costs already reported by the accounting system, such as direct labour in a job costing system, the cost to develop standards and monitor variances is probably low, and the benefit could be relatively high if such monitoring encourages labour to be more efficient. However, other costs, such as indirect materials used during set-ups, may be expensive to track. The benefit from tracking these costs may be low if only very small amounts of materials are used per set-up. These costs are likely to be aggregated into overhead. Standard costs are often set using the most recent year s data. Historical trends may be analyzed and used. Sometimes industrial engineers develop standards by analyzing the manufacturing or service delivery process Recurring favourable variances may indicate that some process has improved. These should be investigated so that standard production practices reflect the process improvements. Variances may also reflect opportunities to examine the manufacturing process and quality of materials to determine improvements. Sometimes the standard is

4 232 Cost Management wrong, and the monitoring process is improved by changing the standard to reflect current operations When the direct materials price variance is large and favourable while direct materials efficiency variance is large and unfavourable, it is possible that lower quality materials are being purchased. This could have a negative effect on the efficiency variance if defective materials are being discarded. Both purchasing and production personnel should be asked whether there has been a change in the quality of materials purchased. Production personnel should also be asked to explain the unfavourable efficiency variances If the direct material price variance is recorded at the time of purchase, direct materials are recorded in inventory at standard cost and do not need to be tracked by purchase date and purchase price. This reduces bookkeeping time and effort and simplifies inventory control. It also clarifies that the price variance occurs at the time of purchase rather than at the time direct materials are used Anchoring bias is a term that refers to a tendency to overly rely on one particular and often irrelevant piece of information while ignoring other relevant information. For example, at the end of an accounting period, management may budget for very high sales revenue next period based solely on the high sales volumes achieved in the prior period, even if the sales were due to a temporary consumer trend. Similarly, costs are often budgeted based largely on prior period costs without taking into account opportunities for greater cost efficiency The contribution margin variance calculates the effects of changes in contribution margins, given the actual level of sales. The contribution margin sales volume variance calculates the effects of changes in units sold, given the standard contribution margins. This information helps managers focus on the reason that the contribution margin is changing. Managers may want to focus on the underlying variable costs, or pricing, or consider product emphasis. These variances help determine whether it s a change in the volume of sales, or change in the price or variable cost that causes the variance. When sales are slow, prices could be lowered, which would be reflected in the contribution margin variance. These types of changes should be investigated The sales price variance reflects the difference between standard and actual selling prices for the volume of units actually sold. This variance is favourable if the actual selling price exceeds the standard price, and it is unfavourable if the reverse is true. The revenue sales quantity variance reflects the difference between the standard and actual quantity of units sold at the standard selling price. This variance will be favourable when actual quantities exceed standard quantities, and it will be unfavourable otherwise. These variances help managers determine whether changes in revenues are driven by changes in selling price or changes in quantities sold. To remedy any problems, this information is quite useful.

5 Chapter 11: Standard Costs and Variance Analysis Each individual type of product in a product mix has a specific contribution margin. As the proportion of each product changes, that is, as the product mix changes, the total contribution margin changes, increasing when the proportion of products with larger contribution margins increase and decreasing as they decrease.

6 234 Cost Management MULTIPLE-CHOICE QUESTIONS Generico Ltd. uses an injection device to regulate the flow of raw materials into moulds in itsproduction process. When the injector device is out of control, the entire production line mustbe shut down. The production data for the past month indicated an unfavourable raw material cost variance,as follows: Budgeted production volume 40,000 units Actual production volume 39,000 units Budgeted raw materials (40,000 x 2 10 per gram) 800,000 Actual raw materials (39,000 x per gram) 1,029,600 Variance (unfavourable) 229,600 The variance was either caused by the injector device being out of control or by random factorsthat would disappear on their own. The production manager must decide whether to shut downproduction to investigate the cause of the variance or wait another month. Data regarding investigation of the cause of the variance are as follows: Cost to inspect injector device (10 300) 3,000 Cost to repair injector device (20 300) 6,000 Lost contribution margin during downtime 1,000 per hour Based on past experience, there is a 10% chance that the injector device is out of control. If it isout of control and not corrected right away, the net cost to the company until the next regularlyscheduled maintenance adjustment will be 90,000. Which of the following represents the materials efficiency variance? a) 93,600 unfavourable b) 69,600 unfavourable c) 78,000 unfavourable d) 58,000 unfavourable e) 156,000 unfavourable Ans: C 39,000 * ( ) * = (78,000) (Appendix 11A) The budget and actual results for Acme Co. Inc. for the first quarter of the year are as follows: Static Budget Actual Results Unit sales: Regular 40,000 15,000 Deluxe 60,000 65,000 Total 100,000 80,000 Unit selling price: Regular 6 6 Deluxe Unit variable costs: Regular 4 3 Deluxe 7 9 Market size (total units 500, ,000 of both products)

7 Chapter 11: Standard Costs and Variance Analysis 235 The total sales (contribution margin) mix variance for the first quarter (rounded to the nearestthousand) is: a) Zero b) 102,000 unfavourable c) 75,000 unfavourable d) 17,000 unfavourable e) 64,000 unfavourable Ans: C [(40,000*(6-4) (15,000*(6-3)] +[(60,000*(12-7) (65,000*(13-9)] (Appendix 11A) Acme Beds Inc. produces two models of beds: Regular and Majestic. Budget andactual data were as follows: Budget Actual Regular Majestic Regular Majestic Selling price per unit Sales volume in units 4,500 5,500 7,200 4,800 Variable costs per unit Master Budget Actual Sales revenue 5,750,000 5,700,000 Variable costs 4,235,000 4,512,000 Contribution margin 1,515,000 1,188,000 Fixed costs 882, ,500 Operating income 632, ,500 Market Data Expected total market sale of beds Actual total market sales of beds 500, ,667 beds beds The sales price variance is: a) 437,500 unfavourable b) 300,000 unfavourable c) 50,000 unfavourable d) 660,000 unfavourable e) 69,000 favourable Ans: B [(4500*300)-(7200*325)]+[(5500*800)-(4800*700)] The following information pertains to Questions and 11.21: Lynn Company uses a standardcost system. Overhead is applied on the basis of direct labour hours (DLH), and the annual practicalcapacity of 42,000 DLH is used in establishing the standard overhead rates. The following summarizesbudget and actual data for the past year: Budget Actual Units produced 100,000 92,000 Direct materials (kilograms) 50,000 47,840 Direct labour hours (DLH) 40,000 37,720 Production costs: Direct materials 200, ,968

8 236 Cost Management Direct labour 500,000 Variable factory overhead 80,000 a Fixed factory overhead 160,000 a a Applied. 471,500 84, ,000 During the year, 90,000 units were sold. There were no beginning or ending work-inprocessinventories, but there were 3,000 units of finished goods on hand at the end of the year The standard cost of goods sold for the past year is: a) 983,000 b) 940,000 c) 874,200 d) 864,800 e) 846,000 Ans: E (200, ,000+80, ,000)/100,000*90, The variable factory overhead flexible budget variance is: a) 12,640 unfavourable b) 4,560 unfavourable c) 9,200 unfavourable d) 11,040 unfavourable e) 4,600 unfavourable Ans: D (80,000/100,000*92000)-(84,640)

9 Chapter 11: Standard Costs and Variance Analysis 237 EXERCISES Direct Labour Variance Sisyphus Company Labour price variance = (Standard price Actual price) Actual labour hours Standard price = 1,900/950 DLH = 2.00 per DLH Actual price = 1,850/920 DLH = per DLH ( ) 920 DLH = 10 Unfavorable Price Variance Labour efficiency variance = (Standard hours for output Actual hours for output) Standard price ( ) 2 = 60 Favorable Efficiency Variance Direct Labour Variance Fine Furniture A. Labour efficiency variance: Standard hours at Standard price Actual hours at Standard price = 1,750 1,680 = 70 Favorable B. Labour price variance: Actual hours at Standard price Actual hours at Actual price = 1,680 1,752 = 72 Unfavorable Direct Material Variances Up North s A. Standard quantity of litres per unit: First calculate the total amount of materials allowed for expected production: (173,600 / 2.80 per litre) = 62,000 litres Then calculate the standard quantity of materials per unit: 62,000 litre / 20,000 units = 3.1 litres per unit B. Direct materials efficiency variance: (Standard quantity for actual production Actual quantity for actual production) Standard price = [(3.1 litre per unit * 19,100 units) 57,300 litres)]*2.80 = 5,348 Favourable

10 238 Cost Management C. Direct materials price variance: (Standard price minus Actual price) Actual materials purchased = [2.80 * 57,300 litres) - 163,305 = 2,865 Unfavorable Fixed Overhead Variances, Solve for Unknown Country Pet Clinic A. Patient hours recorded: 248,000 allocated fixed overhead cost / 40 per hour = 6,200 patient hours B. Budgeted fixed overhead: 40 per hour 6,000 patient hours = 240,000 C. Production volume variance: (Standard patient hours for actual patients minus Budgeted patient hours) Standard allocation rate per hour = [(11,000 patients 0.5 hour per patient) 6,000 hours] 40 per hour = 20,000 Unfavorable D. Actual fixed overhead: Budgeted fixed overhead Actual fixed overhead = Fixed overhead spending variance 240,000 Actual fixed overhead = 24,000 Unfavorable 240, ,000 = 264,000 Actual fixed overhead Fixed and Variable Overhead Variances Robertson Consulting A. Spending overhead variances: Variable overhead spending variance [(15,300 Budgeted variable overhead / 8,500 Standard hours) (14,000 Actual variable overhead / 8,200 Actual hours)] 8,200 Actual hours = 760 Favorable Fixed overhead spending variance = 19,125-19,000 = 125 Favorable B. Overhead allocation rates: Fixed overhead rate: 19,125 Budgeted cost / 8,500 Estimated hours = 2.25 per hour Variable overhead rate: 15,300 Budgeted cost / 8,500 Estimated hours = 1.80 per hour

11 Chapter 11: Standard Costs and Variance Analysis 239 C. Fixed overhead volume variance: (8,300 Standard hours for actual volume 8,500 Estimated hours) 2.25 Fixed overhead rate = 450 Unfavorable D. Variable overhead efficiency variance: (8,300 Standard hours for actual volume 8,200 Actual hours) 1.80 Variable overhead rate = 180 Favorable Direct Labour Variances, Overhead Spending Variance - Kitchen Tile Company A. This question requires a missing piece of information: the actual number of hours worked. However, because the labour efficiency variance is given, the variance formula can be used to solve for actual labour hours as follows: Labour efficiency variance = (Standard hours Actual hours) x Standard price The variance amount is given as 6,720 Favourable, and the standard labour price is given as per hour. The number of standard labour hours is calculated as follows: Actual production = 18,000 tiles Standard efficiency is 6 tiles per labour hour Standard number of labour hours for 18,000 tiles: = 18,000 tiles/6 tiles per hour = 3,000 hours Now solve for actual labour hours using the variance formula: 6,720 = * (3,000 hours Actual hours) 6,720/24 = 3,000 Actual hours 280 = 3,000 Actual hours Actual hours = 3, = 2,720 Quicker approach: The efficiency variance represents the amount by which actual hours exceed standard hours, times the standard price. This means that the efficiency variance represents 280 hours (6,720/24). Because the variance was favourable, 280 fewer hours were used than the standard required. For 18,000 tiles, standard labour hours are 3,000 (18,000/6). Therefore, actual hours are 3, = 2,720 hours. B. The direct labour price variance is calculated using the following formula: Actual labour hours * (Standard price Actual price) = 2,720 hours * ( ) = 1,360 Unfavourable

12 240 Cost Management C. The fixed overhead budget (i.e., spending) variance is calculated by simply taking the difference between standard and actual fixed costs: Standard fixed costs Actual fixed costs = 60,000-58,720 = 1,280 Favourable Direct Materials and Labour Variances, Variances to Investigate - Nakatani Enterprises A. Standard costs for actual output of 15,342 units: Direct materials (15,342 units x 0.8 kg. x 2.00/kg.) Direct labour (15,342 units x 0.2 hrs x 17.00/hour) Total 24, , , B. Direct materials price variance Standard cost for actual purchases (2.00/kg x 11,000 kg.) Actual cost of purchases Price variance 22,000 21, F C. Direct materials efficiency variance Standard quantity of materials for actual output (15,342 x 0.8 kg.) 12,273.6 kg. Actual quantity of materials used 13,252.0kg. Variance in kilograms (978.4) kg. Times standard cost per kilogram 2.00 Efficiency variance (1,956.80) U D. Direct labour price variance Standard cost for actual labour hours (17 x 2,730 hours) Actual labour cost Price variance E. Direct labour efficiency variance Standard labour hours for actual output (15,342 x 0.2 hours) Actual labour hours Variance in hours Times standard cost per hour Efficiency variance 46,410 47,000 (590) U 3, , hours , F F. If managers use 10% of total direct costs as the criteria for investigation, none of these variances would be investigated. However, the direct labour efficiency variance is relatively large compared to total direct labour cost at 11% (5,752.80/52,162.80). Some managers may want to investigate this variance, especially if this company is concerned about quality as a strategy. If quality has decreased as a result of this favourable variance, defective or low quality units could affect Nakatani s reputation and future revenues if customers are disgruntled. If production processes have improved, and

13 Chapter 11: Standard Costs and Variance Analysis 241 there is no adverse change in quality, managers might want to change the labour quantity standard Direct Materials and Direct Labour Variances, Journal Entries - Nell Company A. Direct material price variance [( ) x 100,000] Direct material efficiency variance [(5 * 10,000-60,000) x 0.20] Direct labour price variance [( ) x 3,900] Direct labour efficiency variance [(0.4 * 10,000-3,900) x 7.00] B. Journal entries: Raw materials inventory (100,000 lbs at 0.20/kg.) Direct materials price variance Accounts payable 3,000 F 2,000 U 780 U 700 F 20,000 3,000 17,000 Work in process inventory (5*10,000*0.20) Direct materials efficiency variance Raw materials inventory (60,000 * 0.20) 10,000 2,000 Work in process inventory (0.4*10,000*7.00) Direct labour price variance Direct labour efficiency variance Wages payable (3,900 * 7.20) 28, , , Direct Labour Variances, Solve for Unknowns Chase Company A. The exercise provides only partial information, so the standard hourly pay rate for direct labour must be calculated in a series of steps. First, determine the direct labour budget: Total direct labour budget = 7,000 units Standard DL cost per unit = 168,000 Standard DL cost per unit = 168,000 / 7,000 units = 24 Second, determine the direct labour flexible budget: Standard DL budget for actual volume (i.e., DL flexible budget) = 7,200 units 24 DL cost per unit = 172,800

14 242 Cost Management Third, use the preceding calculations and the direct labour variance information to determine total actual direct labour costs and total actual labour hours: Standard DL cost for actual volume Actual DL cost = Total DL variance 172,800 Actual DL cost = 1,660 Unfavourable Actual DL cost = 172, ,660 = 174,460 Total actual DL cost = Actual DL hours Actual DL cost per hour 174,460 = Actual DL hours per hour Actual DL hours = 174,460 / per hour = 14,300 hours Fourth, use the preceding calculations and the direct labour price variance to calculate actual direct labour hours at the standard rate: Actual DL hours at standard rate Actual DL hours at actual rate = DL price variance Actual DL hours at standard rate 174,460 = 2,860 Unfavourable Actual DL hours at standard rate = 174,460 2,860 = 171,600 Finally, use the preceding information to calculate the standard wage rate: Actual DL hours Standard wage Rate = Actual DL hours at standard rate 14,300 hours Standard wage rate = 171,600 Standard wage rate = 171,600 / 14,300 hours = 12 per hour B. The standard direct labour hours per unit can be calculated using the total direct cost per unit and the standard direct labour cost per hour (see calculations in Part A): Standard DL cost per unit = Standard DL hours per unit Standard DL cost per hour 24 per unit = Standard DL hours per unit 12 per hour Standard DL hours = 24 per unit / 12 per hour = 2 hours per unit C. Actual direct labour hours = 14,300 (see calculations in Part A) D. Direct labour efficiency variance: (Standard DL hours for actual volume Actual DL hours) Standard rate per hour = [(2 hours per unit 7,200 units) 14,300 hours] 12 per hour = 1,200 Favourable E. Journal entries for direct labour

15 Chapter 11: Standard Costs and Variance Analysis 243 Work in process inventory (7,200*2.00*12.00) Direct labour price variance Direct labour efficiency variance Wages payable (14,300*12.20) 172,800 2,860 1, , Variable and Fixed Overhead Variances, Journal Entries - Derf Company Standard fixed overhead is 135,000 x 0.20 = 27,000 Standard variable overhead is 135,000 x 0.80 = 108,000 The standard fixed overhead allocation rate is 27,000/(9,000 x 2) = 1.50 per hour The standard variable overhead allocation rate is 108,000/(9,000 x 2) = 6.00 per hour A. The variable overhead spending variance is: [6.00 (108,500/17,200)] x 17,200 = 5,300 U B. The variable overhead efficiency variance is: [8,500 * 2-17,200] x 6 = 1,200 U C. The fixed overhead spending (budget) variance is: 27,000-28,000 = 1,000 U D. The fixed production volume variance is: 1.50 x [(8,500 x 2) (9,000 x 2)] = 1,500 U E. Journal entries Variable overhead cost control (actual cost) Accounts payable and other accounts Work in Process inventory (8,500 x 2 hrs x 6/hr) Variable overhead cost control Variable overhead spending variance Variable overhead efficiency variance Variable overhead cost control 108, , , ,000 5,300 1,200 6,500 Fixed overhead cost control Accounts payable and other accounts 28,000 WIP inventory (8,500 x 2 x 1.50) Fixed overhead cost control 25,500 28,000 25,500

16 244 Cost Management Fixed overhead spending (budget) variance Production volume variance Fixed overhead cost control 1,000 1,500 Ending WIP, finished goods, and/or COGSa Variable overhead spending variance Variable overhead efficiency variance Fixed overhead spending (budget) variance Production volume variance 9,000 a 2,500 5,300 1,200 1,000 1,500 The total variance of 9,000 U would be prorated based on the ending balances in work-in-process inventory, finished goods inventory, and cost of goods sold Profit-Related Variances (Appendix 11A) Sunflower Company A. Contribution Margin Sales Mix Variance Unfavourable B. Contribution Margin Sales Quantity Variance 590 Favourable C. Contribution Margin Sales Volume Variance Favourable Profit-Related Variances (Appendix 11A) Afos Sofas Inc. A. Sales quantity variance = (Actual sales volume at budgeted mix - Budgeted volume) x Budgeted contribution margin Budget Deluxe Total Budgeted Sales Volume 4,000 6,000 10,000 Budgeted Sales Mix 4,000 / 10,000 = 40% 6,000 / 10,000 = 60% Total Actual units sold = 6, ,200 = 11,000 units Standard [(11,000 *0.4) - 4,000] * ( ) = 56,000 favourable Deluxe [(11,000 * 0.6) - 6,000] * ( ) = 138,000 favourable 56,000 F + 138,000 F = 194,000 favourable B. Industry volume variance = (Actual market size - Budgeted market size) x Budgeted market share x Budgeted average contribution margin = (220, ,000) * [(10,000)/250,000] * [1,940,000/10,000]

17 Chapter 11: Standard Costs and Variance Analysis 245 = -30,000 * 4% * 194 = 232,800 unfavourable C. The actual contribution margin per unit was higher for Standard sofas (i.e. 150 actual versus 140 budget) and was lower for Deluxe sofas (i.e. 165 actual versus 230 budget). However, the contribution margin for Deluxe sofas is higher than for Standard sofas. Therefore, by selling more of the Standard sofas and less of the Deluxe sofas, an unfavourable mix variance would result. As well, the decrease in the contribution margin per Deluxe sofa resulted in a decrease in the actual versus budgeted average contribution margin [i.e actual versus 194 budget] and a decrease in income. The actual average variable cost per sofa of was lower than the budgeted average variable cost of , which should have contributed to increasing, not decreasing, income Profit-Related Variances (Appendix 11A) Slumber CozyInc. A. Sales volume variance = Budgeted contribution margin x (Actual sales volume Budgeted sales volume) Budgeted Regular CM = = 80 Budgeted Majestic CM = = 210 Regular 80 * (7,200-4,500) = 216,000 favourable Majestic 210 * (4,800-5,500) = 147,000 unfavourable 216,000 F - 147,000 U = 69,000 favourable B. Industry volume variance = (Actual market size - Budgeted market size) x Budgeted market share x Budgeted average contribution margin = (666, ,000) * [(4, ,500)/500,000] * [1,515,000/(4, ,500)] = 166,667 * 0.02 * = 505,000 F C. The actual contribution margin per unit was higher for Regular beds (i.e. 87 actual versus 80 budget) but was lower for Majestic beds (i.e. 117 actual versus 210 budget). Although more Regular beds were sold, which would have a positive impact on profits, the significant decrease in the number of Majestic beds sold [the model with the higher contribution margin] and the decrease in the contribution margin per Majestic bed resulted in a decrease in the actual versus budgeted average contribution margin [i.e. 99 actual versus budget] and a decrease in income. The actual average variable cost per bed of 376 was lower than the budgeted average variable cost of , which should have contributed to increasing, not decreasing, income.

18 246 Cost Management Profit-Related Variances (Appendix 11A) - Mitchellville Products Company A. Revenue budget variance = 60,000 53,200 = 6,800 Unfavourable B. Sales price variance: Standard unit price = 60,000/4,000 = 15 Actual unit price = (53,200/3,800) = 14 Sales price variance = (15-14) x 3,800 = 3,800 Unfavourable C. Revenue sales quantity variance = (4,000 3,800) x 15 = 3,000 Unfavourable D. The standard contribution margin is Sales Less: Variable manufacturing Variable selling and administration Contribution margin 60,000 16,000 8,000 36,000 Becausecontribution margin represents 4,000 units, the contribution margin per unit must be 36,000/4,000 = 9. Then, the contribution margin sales volume variance is 9 x (4,000-3,800) = 1,800 U Contribution Margin Variances, Analysis (Appendix 11A) - Metropolitan Motors A. The contribution margin budget variance is the difference between the standard contribution margin and the actual contribution margin. First, calculate the contribution margin at budget: Economy Family Luxury (10*400) (20*800) (5*1,300) 4,000 16,000 6,500 26,500 The average contribution margin per sale is 26,500/35 =

19 Chapter 11: Standard Costs and Variance Analysis 247 The actual contribution margin is Economy Family Luxury Total ,625 7,500 4,200 17,325 The average contribution margin per sale is 17,325/38 = Contribution margin budget variance = 17,325-26,500 = 9,175 U because the actual contribution margin is less than standard contribution margin. B. The contribution margin variance reflects the effects of the change in contribution margin, given the actual level of sales. First calculate what the contribution margin would have been at actual sales and standard contribution margin: Economy Family Luxury 25 x x x 1, ,000 8,000 3,900 21,900 The average contribution margin at actual sales mix, standard contribution margin is 21,900/38 = Then take the difference between this and the actual contribution margin. Contribution margin variance = 21,900-17,325 = 4,575 U The contribution margin sales volume variance is the difference between the standard volume, mix, and contribution margin and the actual mix and volume at standard contribution margin or 21,900-26,500 = 4,600 U Check: The two variances should equal the contribution margin budget variance. 9,175U = 4,575 U + 4,600 U C. The contribution margin sales quantity variance is the difference in actual quantity sold and the standard quantity, given the standard sales mix and standard contribution margin. The average contribution margin at standard sales mix and standard contribution margin was calculated above in part A. (35-38) x = 2, F

20 248 Cost Management The contribution margin sales mix variance is the difference between the standard sales mix and the actual sales mix given actual sales at standard contribution margin. This can be calculated two different ways. The actual units and actual sales mix at standard contribution margin total is 21,900. The actual units at standard sales mix and standard contribution margin is x 38 = 28, So the total variance = 21, ,771 = 6, U. Alternatively, the averages from above can be used as follows Contribution margin sales mix variance = ( ) x 38 = 6, U These two variances should sum to the contribution margin sales volume variance of 4,600, and they do (6,871-2,271 = 4,600). D. No, management would not be pleased. It appears that the bonus induced the salespeople to put more effort into selling the low margin economy cars at the expense of the higher markup lines. Further, the price variance implies that the salespeople also accepted lower prices on the already narrow markups for the economy cars Direct Cost and Overhead Variances, Decision to Automate - Plush Pet Toys [Note: This problem requires knowledge of decision making from Chapter 4.] A. Direct materials variances Direct material price variance = (2.00 per metre*30,000 metres) - 62,000 = 60,000-62,000 = 2,000 unfavourable because the company paid more than standard Direct material efficiency variance = (15 metres per lot * 2,400 lots 34,000 metres)*2.00 per metre = (36,000 metres 34,000 metres)*2.00 per metre = 4,000 favourable because the company used fewer metres than at standard Direct labour variances: Direct labour price variance = (10 per hour x 4,200 hours) - 39,000 = 42,000-39,000 = 3,000 favourable Direct labour efficiency variance = (2 hrs per lot * 2,400 lots 4,200 hours)*10 per hour = (4,800 hours 4,200 hours)*10 = 6,000 favourable because the company used fewer hours than at standard

21 Chapter 11: Standard Costs and Variance Analysis 249 Variable overhead spending variance = (5 per lot*2,400 lots - 12,000) = 12,000-12,000 = 0 There is no spending variance for variable overhead. Fixed overhead budget variance = 24,000-24,920 = 920 unfavourable because the company spent more than standard Fixed overhead production volume variance Given that fixed overhead is allocated using the following rate: 24,000/1,000 = 24/lot = [(1,000 lots 2,400 lots)*24/lot] = 33,600 favourable because more lots were produced than expected B. 1. Reduction in labour hours (2.0 hours 1.5 hours) Times cost per hour Cost savings per lot 0.5 hours per lot 10 per hour 5.00 per lot 2. Cost savings per month = (1,000 lots * 5.00 per lot) = 5,000 Cost savings over 5 years = (5,000 per month * 60 months) = 300,000 The maximum price the company would be willing to pay for the new equipment is 300,000. This is equal to the expected labour cost savings over 5 years (ignoring the time value of money) Journal Entries for Closing Variances - Fine Products Manufacturing Company A. Total variances = 7,900 unfavourable. Because anything greater than 5,000 is considered material, the total variance amount is material. B. Total WIP, FG, and COGS = 32,000. Each inventory and COGS account gets a portion of the variance: Work in Process (2,000/32,000 x 7,900) Finished goods (6,000/32,000 x 7,900) Cost of goods sold (24,000/32,000 x 7,900) Total 494 1,481 5,925 7,900

22 250 Cost Management Journal Entry: Work in process inventory Finished goods inventory Cost of goods sold Direct materials efficiency variance Variable overhead spending variance Direct materials price variance Labour price variance Labour efficiency variance Fixed overhead budget variance Variable overhead efficiency variance 494 1,481 5,925 1,500 1,000 2,000 5,000 2, , Profit-Related Variances (Appendix 11A) - Pet Toys Inc. A. Revenue budget variance = total budgeted sales total actual sales = (450, ,500) =40,500 U Revenue sales quantity variance = total budgeted sales total actual unit sales at standard price Standard unit selling price Frisbees = 300,000 / 100,000 = 3.00 Standard units of Plush Toys = Frisbees units / 2 = 100,000 /2 = 50,000 Standard unit selling price Plush Toys = 150,000 / 50,000 = 3.00 Frisbee Plush toys Total 95,000 x 3 40,000 x 3 135,000 Actual Unit Sales at Standard Prices 285, , ,000 = (450, ,000) = 45,000 U Sales price variance = total actual sales total actual unit sales at standard price = (409, ,000) = 4,500 F

23 Chapter 11: Standard Costs and Variance Analysis 251 B. Standard contribution margin Frisbees = 125,000 / 100,000 = 1.25 Standard contribution margin Plush Toys = 100,000 / 50,000 = 2.00 Frisbee Plush toys Total 95,000 x ,000 x 2.00 Standard Contribution Margin 118,750 80, ,750 Standard units sold at standard Actual units sold at actual Actual units sold at actual sales mixand standard CM sales mix and standard CM sales mix and actual CM (100,000x ,000x2) (95,000x ,000x2) (95,000x ,000x1.40) 225, , ,250 CM sales volume variance Contribution margin variance (225, ,750) = 26,250 U (198, ,250)= 4,500 F Contribution margin budget variance (225, ,250) = = 21,750 U C. Standard units sold at standard sales mix and standard CM 225,000 Actual units sold at standard sales mix and standard CM [(135,000 x.67 x 1.25)+(135,000 x.33 x 2)] 202,163 CM sales quantity variance (225, ,163) = 22,837 U Actual units at actual sales mix and standard CM (95,000x ,000 x 2) 198,750 Contribution margin sales mix variance (202, ,750) = 3,413U Contribution margin sales volume variance (22,837 U + 3,413 U) = 26,250 U

24 252 Cost Management PROBLEMS Cost Variances, Variance Analysis, and Employee Motivation - Raging Sage Coffee A. For a coffee cart business, workers are scheduled with more help available when the shop is busy, such as in the morning. Although each worker s hours vary, the schedule remains fairly fixed, so the cost structure includes a high proportion of fixed cost. B. In this business, workers need to be at the cart regardless of the number of customers. Therefore, the direct labour efficiency variance is meaningless and should not be calculated because it would be measuring whether the clerks sold as many cups of coffee per labour hour as was expected. Labour costs are fixed, so the computation would reflect a revenue variance, rather than a labour efficiency variance. C. Price variance for coffee beans: Standard cost of actual coffee beans purchased (240 kg x 6.00 per kg) Actual cost of coffee beans purchased Price variance Efficiency variance for coffee beans: Coffee beans at standard kgs. (0.04 kg per cup x 8,260 cups) Actual beans Variance in kilograms Standard cost per kilogram Efficiency variance 1,440 1,800 (360) U kg 224.0kg kg F D. The quantity standard for direct labour implies that 20 cups should be sold per hour of clerk/brewer time: 0.05 hours per cup x 60 minutes per hour = 3 minutes per cup In 60 minutes, 20 cups are expected to be made and sold Expected sales volume (600 clerk/brewer hours x 20 cups per hour) Actual sales volume Difference between expected volume and actual volume 12,000 cups 8,260 cups (3,740) cups E. There is an unfavourable coffee bean price variance, a favourable coffee bean efficiency variance, and sales were off by about 31% (3,740 cups/12,000 cups). These variances might be related. One possibility is that the higher cost of coffee beans caused the clerks/brewers to reduce the quantity of coffee beans used per cup. This would have resulted in weaker coffee, which might have caused customers to go elsewhere.

25 Chapter 11: Standard Costs and Variance Analysis 253 The following are other possible explanations for the unfavourable sales volume variance: A competing coffee business opened nearby. A nearby employer went out of business or launched a major lay-off of employees. There was employee turnover. A clerk/brewer who was well-liked by customers left and was replaced by a clerk/brewer who was often impolite to customers. There was road construction nearby, disrupting traffic to the shopping centre. Nearby competitors decreased their selling prices. Business fluctuates by season There was simply an unexplained fluctuation in sales F. Instead of basing a bonus based on cost variance measures, give employees a bonus based on profitability. This provides them motivation to encourage customers to return, increasing revenue, and also to contain costs Cost Standards, Cost Variances, Improving Cost Variance Information - Sunglass Guys A. Standard overhead rate per direct labour hour: Calculate total estimated overhead at normal production volume: Estimated overhead = (4,300 x 8.15) + (1,400 x 12.32) + 235,707 = 288,000 Calculate estimated labour hours at normal production volume: Estimated hours = 0.2 x 4, x 1,400 = 1,280 hours Calculate standard rate by dividing estimated cost by estimated hours: Rate = 288,000/1,280 = 225 per direct labour hour B. This method would be useless for monitoring and control because the fixed and variable overhead costs are not separated. When the production volume variance is commingled with the fixed overhead budget variance and variable overhead spending variances, spending variances cannot be calculated, so no information is available about cost control.

26 254 Cost Management C. The recommendation is to separate fixed and variable overhead costs into separate standards. Only the spending variances will be useful for monitoring and controlling overhead costs. Using normal monthly volume, the fixed overhead budget variance is: Estimated fixed overhead cost (i.e., static budget) Actual fixed overhead cost = 235, ,859 = 2,152 U The variable overhead spending variance (using units of production as the allocation base): Standard variable overhead for actual production Actual variable overhead cost = (8.15 * 4,500 Regular units) + (12.32 * 1,300 Deluxe units) - 54,238 = 36, ,016-54,238 = 1,547 U D. To calculate the production volume variance, first determine what the fixed overhead standard rate would have been if it had been calculated separately from the variable overhead standard rate: (See computation of normal labour hours in the solution to Part A.) Standard fixed overhead costs/normal number of direct labour hours = 235,707 / 1,280 = per labour hour Production volume variance: Standard labour hours for actual production (0.2 * 4,500 Regular * 1,300 Deluxe) Normal labour hours Volume variance in labour hours Times the standard overhead rate Production volume variance 1,290 hours 1,280 hours 10 hours ,842 F Double-check the fixed overhead variance calculations in Parts C and D as follows: Standard fixed overhead cost allocated to actual production: Regular sunglasses: [(184.15*0.2) * 4,500] Deluxe sunglasses: [(184.15*0.3) * 1,300] Total fixed overhead allocated Less actual fixed overhead costs Total fixed overhead variance 165,735 71, , ,859 (305) U Sum of individual variances: [(2,152) U + 1,842 F] (310) U Difference due to rounding

27 Chapter 11: Standard Costs and Variance Analysis 255 To calculate the variable overhead efficiency variance, the standard volume of allocation base for actual output is compared to the actual volume of allocation base. Because variable overhead is allocated using actual units, an efficiency variance never arises (actual volume of units always equals actual volume of units). Therefore, the efficiency variance will be 0. E. If labour hours and costs are fixed, they do not vary with production. Therefore, labour hours provide a poor allocation base for variable overhead cost. A better option would be to allocate variable overhead using units produced because the variable overhead costs are more related to units than to labour Developing Direct Cost Standards, Cost Variances, Using Variance Analysis - The Mighty Morphs A. Documentation price variance for MMMs: Actual quantity x (standard price per unit actual price per unit) = [(825 books used x (5-4.75)] = B. Efficiency variance for DVDs (Standard quantity actual quantity) x standard price = [(1.08DVDs per unit x ( ) games produced) 2,025DVDs used] x.35/dvd = (((1,944 2,025) *.35) = U C. Labour price variance for both games: (Standard price actual price) x actual labour hours = (15-795/55) * 55 Labour efficiency variance for both games: (Standard hours for actual output actual hours) x standard price = [(0.01 x 1,000) + (0.03 x 800) 55] x 15 = [( ) 55] x 15 Total labour variance 30 F 315 U 285 U

28 256 Cost Management D. If there were no waste, the company would incur costs for only one DVD and one documentation book per game produced. Thus, the cost of waste is equal to the number of DVDs and documentation books used in excess of one per unit, valued at standard cost: Waste for DVDs: [Actual DVDs used (1, ) games produced] x 0.35 = (2,025 1,800) x Waste for documentation books: (Actual Power Puffs books used 1,000) x 3 + (Actual MMM books used 800) x 5 = [(1,005 1,000) x 3] + [( ) x 5] Total waste E. Pros: Cons: It may be less costly to allow waste in the standard than to inspect incoming materials or to pay for higher quality materials. The company has done it this way a long time, and change might be difficult for employees. Several waste-related opportunity costs arise from defective units. As waste increases, it is likely that the number of defective units sold increases. Greater defect rates reduce customer satisfaction and reduce sales. By eliminating waste altogether, this cost is avoided Cost Variance Analysis, Using Variance Information - Baker Street Animal Clinic A. The technicians have argued that the cost variance was caused by the price increase. Thus, the total variance can be separated into a price variance and an efficiency variance. Normally, the price variance is calculated using the purchase quantity. However, no information is given about the quantity purchased. Also, the problem presents total cost for serum used of 2,270, which results in a (270) total variance. However, the serum for 2,000 injections costs 105 per 1,000cc. Following are calculations for the price variance. Price variance for serum: Standard quantity of serum for actual injections Times amount of price increase per cc: [(100/1,000 cc) (105/1,000 cc)] = ( ) per cc Serum Price Variance (20,000 cc *.005) 20,000 cc (.005) per cc (100) U

29 Chapter 11: Standard Costs and Variance Analysis 257 Efficiency variance for serum: The efficiency variance cannot be calculated using the usual method because the quantity of serum used is unknown. However, the efficiency variance can be calculated by subtracting the price variance from the total serum cost variance. Total variance (given in the problem) Price variance Serum Efficiency Variance (270) U (100) U (170) U B. The unfavourable efficiency variance represents the cost of wasted serum. To see this, consider the formula for the efficiency variance: Efficiency Variance = Standard cost * (Standard quantity Actual quantity) The difference between the standard quantity and the actual quantity is the amount of serum wasted. At a standard cost of.10 per cc, the volume of wasted serum is estimated to be 1,700 cc (170 unfavourable efficiency variance/.10 per cc). Is this a significant amount of waste? This is a matter of judgment. Below are several ways to quantify the significance. Waste, relative to standard quantity of serum: Standard quantity of serum = 2,000 injections * 10 cc Percent serum waste (1,700 cc/20,000 cc) 20, % Note: The waste could also have been calculated using percent of standard cost: 170 efficiency variance/2,000 standard cost = 8.5% Number of additional injections that could have been given: Waste of 1,700 cc / 10 cc per injection 170 injections Following are possible issues to discuss when answering this question: The percent waste (8.5%) might or might not be considered a significant cost. Given the nature of operations at the Baker Street Animal Clinic, it would be reasonable for waste to be very close to zero. Had there been zero waste, 8.5% or 170 more injections could have been given. Perhaps the waste is a sign that the technicians are wasteful in other areas, too. There could be a significantly larger problem. C. The managerwould probably be concerned about the unfavourable efficiency variance. The manager could ask the technicians to review their procedures and to identify how and where waste is occurring. Once the reasons for waste are identified, the managercould help the technicians establish new procedures to minimize or eliminate the waste.

30 258 Cost Management If the technicians are unable to provide reasonable explanations for the waste, the manager might become concerned that someone is stealing serum and then selling or using it elsewhere. If the manager considered the cost to be sufficiently large, he/she might institute new procedures for monitoring the physical use of serum. However, this type of approach might cost more than the benefit. Perhaps the easiest and most cost-effective solution would be to provide the technicians with incentives based on the efficiency variance. The efficiency variance could be used as part of the technicians performance evaluation. This would encourage them to seek efficiency improvements on their own Direct Labour, Variable and Fixed Overhead Variances, Solve for Unknowns Phi Company and Pho Company Missing information for Phi Company: The flexible budget variable overhead is 21,000. The standard rate per labour hour is 2, so the number oflabour hours budgeted for actual units are 10,500. The standard for labour hours allowed per unit is 5so the actual number of units produced this period is 10,500/5 =2,100 (answer to I). Budgeted fixed overhead is 40,000 allocated at a rate of 4 per labour hour, so thebudgeted number of labour hours were 40,000/4 = 10,000 (answer to A). Standard labour is 5 hours per unit, so budgeted unit volume is 10,000/5 =2,000 (answer to H). The fixed overhead allocated to production is (I) 2,100 actual units 5 standard labour hours 4 standard fixed overhead rate = 42,000 fixed overhead allocated to production (answer to F). Actual fixed overhead cost = Allocated fixed overhead costs of 42,000 + the total fixed overhead budget variance of 600 (unfavorable) = 42,600 actual total fixed overhead costs (answer to E). The fixed overhead volume variance (i.e., production volume variance) is actual volume less budgeted volume at the standard labour hours and rate = (2,100 2,000) 5 4 = 2,000 favourable fixed overhead volume variance (answer to G). To determine actual labour hours per unit, begin with the variable overhead efficiency variance of 840 F. Fewer labour hours were used than the standard. The number of hours used was 840/2 hours per unit = 420 hours less than at standard. Standard hours for 2,100 units are 10,500 less 420 hours = 10,080 actual labour hours. Divide total actual labour hours by 2,100 units produced to calculate 4.8 actual labour hours per unit (answer to B).