Part 1 Study Unit 10 Cost And Variance Measures By Ronald Schmidt, CMA, CFM
Variance Analysis and overview A budget communicates to employees the organization s operational and strategic objectives Considerations: Evaluations system must be used to monitor progress Feedback must be timely
Variance Analysis and overview Variance analysis is the basis of any performance evaluation system. On the cost side, a favorable variance occurs when actual costs are less than standard costs. An unfavorable variance occurs when actual costs are greater than standard costs. On the revenue side, a favorable variance occurs when actual revenues are greater than budgeted revenues. An unfavorable variance occurs when actual revenues are less than budgeted revenues.
Variance Analysis and overview The significance of variances depends not only on their amount but also on their direction, frequency, and trend. It enables management by exception the practice of giving attention primarily to significant deviations from expectations. Assignment of responsibility = Budget owner Cost centers = cost drivers = controllable costs Allocation / indirect costs Crucial part of variance analysis is the assignment of responsibility to those most likely to have information that will help find solutions. Constructive approach is to promote learning and continuous in manufacturing, not to assign blame.
Variance Analysis overview Objectives of the budget: performance? Budget vs. Actual, evaluate the trend, and develop a rolling Forecast
Flexible budget and sales-volume variance Static budget = flexible budget and sales volume variance Flexible budget variance Diff. between the actual results and the budgeted amount for the actual activity level. The costs that should have been incurred given the actual level of production. The actual level of production is based on the actual output while still using the standard level of inputs. Variance could be due to: Selling Price Input costs Input quantities
Flexible budget and sales-volume variance The sales-volume variance is the difference between the flexible budget and static budget amounts if selling prices and costs are constant.
Flexible budget and sales-volume See page 343 variance ACTUAL RESULTS = ACTUAL INPUTS x ACTUAL PRICE FLEXIBLE BUDGET = ACTUAL INPUTS x STANDARD PRICE STATIC BUDGET = BUDGETED INPUTS x STANDARD PRICE
SU 10.1 Practice Question 1 The purpose of identifying manufacturing variances and assigning their responsibility to a person/department should be to A B C D Use the knowledge about the variances to promote learning and continuous improvement in the manufacturing operations. Trace the variances to finished goods so that the inventory can be properly valued at year-end. Determine the proper cost of the products produced so that selling prices can be adjusted accordingly. Pinpoint fault for operating problems in the organization.
SU 10.1 Practice Question 1 Answer Correct Answer: A The purpose of identifying and assigning responsibility for variances is to determine who is likely to have information that will enable management to find solutions. The constructive approach is to promote learning and continuous improvement in manufacturing operations, not to assign blame. However, information about variances may be useful in evaluating managers performance.
SU 10.1 Practice Question 2 A difference between standard costs used for cost control and the budgeted costs of the same manufacturing effort can exist because A B C D Standard costs represent what costs should be, whereas budgeted costs are expected actual costs. Budgeted costs are historical costs, whereas standard costs are based on engineering studies. Budgeted costs include some slack, whereas standard costs do not. Standard costs include some slack, whereas budgeted costs do not.
SU 10.1 Practice Question 2 Answer Correct Answer: A In the long run, these costs should be the same. In the short run, however, they may differ because standard costs represent what costs should be, whereas budgeted costs are expected actual costs. Budgeted costs may vary widely from standard costs in certain months, but, for an annual budget period, the amounts should be similar.
SU 10.1 Practice Question 3 The controller of a company holds a monthly meeting where any department that has a 10% unfavorable variance to budget must explain the variance and develop a plan to remedy the situation. This is an example of A Activity-based management. B Cost management. C Continuous improvement. D Management by exception.
SU 10.1 Practice Question 3 Answer Correct Answer: D Variance analysis is an important tool for the management accountant. It enables management by exception, which is the practice of giving attention primarily to significant deviations from expectations. Managers must use their judgment to determine the most efficient use of their limited time. Concentrating on operations that are not performing within expected limits is likely to yield the best ratio of benefits to costs.
Remember Flexible budget = Actual level of production x standard costs
Components of the flexible Budget DM variance Price variance Quantity or usage variance Materials mix variance / yield variance DL variance Rate variance Efficiency variance Labor mix variance / yield variance MOH variance (By Jim Clemons) 4 way analysis VOH spending variance VOH efficiency variance FOH spending variance (budget variance) FOH production-volume variance
Flexible budget Remember a flexible budget adjusts for changes in the volume of activity. It can be adapted to any level of production. Flexible budget variances result from variations in the efficiency and effectiveness of producing actual output. They are the differences between actual results and flexible budget amounts. See example on page 343
SU 10.2 Question 1 A manufacturing firm planned to manufacture and sell 100,000 units of product during the year at a variable cost per unit of $4.00 and a fixed cost per unit of $2.00. The firm fell short of its goal and only manufactured 80,000 units at a total incurred cost of $515,000. The firm s manufacturing cost variance was A. $85,000 favorable. B. $35,000 unfavorable. C. $5,000 favorable. D. $5,000 unfavorable.
SU 10.2 Question 1 Answer Correct Answer: C The company planned to produce 100,000 units at $6 each ($4 variable + $2 fixed cost), or a total of $600,000, consisting of $400,000 of variable costs and $200,000 of fixed costs. Total production was only 80,000 units at a total cost of $515,000. The flexible budget for a production level of 80,000 units includes variable costs of $320,000 (80,000 units $4). Fixed costs would remain at $200,000. Thus, the total flexible budget costs are $520,000. Given that actual costs were only $515,000, the variance is $5,000 favorable.
SU 10.2 Question 2 To monitor total cost, total revenue, and net profit based upon production levels, a manager should use A. B. C. Both flexible budgeting and standard costing. Static budgeting but not standard costing. Standard costing but not flexible budgeting. D. Static budgeting and standard costing.
SU 10.2 Question 2 Answer Correct Answer: A A flexible budget is a set of static budgets prepared in anticipation of varying levels of activity. Unlike a static budget, the use of a flexible budget permits effective evaluation of actual results when actual and expected production differ. Setting cost standards facilitates preparation of a flexible budget. For example, a standard unit variable cost is useful in determining the total variable cost for a given output.
DM / DL variances DL rate variance AQ x (AP SP) DL efficiency variance SP x (AQ SQ) Mix and yield variances Substitutable products Weighted average standard price Standard mix of inputs (SPSM) Actual mix of inputs (SPAM) Mix variance = ATQ x (SPSM SPAM) Yield variance = (STQ ATQ) x SPSM MIX + YIELD variances = EFFICIENCY variance
SU 10.3 Question 1 Blaster, Inc., a manufacturer of portable radios, purchases the components from subcontractors to use to assemble into a complete radio. Each radio requires three units each of Part XBEZ52, which has a standard cost of $1.45 per unit. During May, Blaster experienced the following with respect to Part XBEZ52. Units Purchases ($18,000) 12,000 Consumed in manufacturing 10,000 Radios manufactured 3,000
SU 10.3 Question 1 (cont.) During May, Blaster incurred a purchase price variance of During May, Blaster incurred a purchase price variance of A. $450 unfavorable. B. $450 favorable. C. $500 favorable. D. $600 unfavorable
SU 10.3 Question 1 Answer Correct Answer: D Blaster s purchase price variance is calculated as follows: Purchase price variance = AQ (SP AP) = 12,000 parts ($1.45 $1.50) = 12,000 $0.05 = $600 unfavorable Incorrect Answers: A: The standard quantity needed for the actual output times the $.05 unfavorable price variance per part equals $450 unfavorable. B: The variance is unfavorable, and $450 is the amount of the variance that relates only to the standard input for the actual output. C: The variance is unfavorable. Furthermore, the variance is based on the quantity purchased, not the quantity consumed. [Note: The materials price variance is sometimes isolated at the time of transfer to production.]
SU 10.3 Question 2 Blaster, Inc., a manufacturer of portable radios, purchases the components from subcontractors to use to assemble into a complete radio. Each radio requires three units each of Part XBEZ52, which has a standard cost of $1.45 per unit. During May, Blaster experienced the following with respect to Part XBEZ52. Units Purchases ($18,000) 12,000 Consumed in manufacturing 10,000 Radios manufactured 3,000
SU 10.3 Question 2 (cont.) During May, Blaster incurred a materials efficiency variance of A. $1,450 unfavorable. B. $1,450 favorable. C. $4,350 unfavorable. D. $4,350 favorable.
SU 10.3 Question 2 Answer Correct Answer: A Standard usage was three parts per radio at $1.45 each. For a production level of 3,000 units, the total materials needed equaled 9,000 parts, but materials actually used totaled 10,000 parts. Thus, the variance is $1,450 unfavorable {SP (AQ SQ) = [$1.45 standard cost per part (10,000 actually used 9,000 standard usage)]}. Incorrect Answers: B: The variance is unfavorable. The actual quantity used exceeded the standard input allowed. C: Assuming that 12,000 parts were consumed results in $4,350 unfavorable. D: Assuming that 12,000 parts were consumed and that the variance is favorable results in $4,350 favorable.
SU 10.4 Question 1 Under a standard cost system, direct labor price variances are usually not attributable to A. Union contracts approved before the budgeting cycle. B. Labor rate predictions. C. The use of a single average standard rate. The assignment of different D. skill levels of workers than planned.
SU 10.4 Question 1 Answer Correct Answer: A The direct labor price (rate) variance is the actual hours worked times the difference between the standard rate and the actual rate paid. This difference may be attributable to (1) a change in labor rates since the establishment of the standards, (2) using a single average standard rate despite different rates earned among different employees, (3) assigning higher-paid workers to jobs estimated to require lower-paid workers (or vice versa), or (4) paying hourly rates, but basing standards on piecework rates (or vice versa). The difference should not be caused by a union contract approved before the budgeting cycle because such rates would have been incorporated into the standards. Incorrect Answers: B: Predictions about labor rates may have been inaccurate. C: Using a single average standard rate may lead to variances if some workers are paid more than others and the proportions of hours worked differ from estimates. D: Assigning higher paid (and higher skilled) workers to jobs not requiring such skills leads to an unfavorable variance.
SU 10.4 Question 2 Zazoo, Inc. specializes in reviewing and editing technical magazine articles. Zazoo sets the following standards for evaluating the performance of the professional staff: Annual budgeted fixed costs for normal capacity level of 10,000 articles reviewed and edited $600,000 Standard professional hours per 10 articles 200 hours Flexible budget of standard labor costs to process $10,000,000 10,000 articles The following data apply to the 9,500 articles that were actually reviewed and edited during the current year. Total hours used by professional staff 192,000 hours Flexible costs $9,120,000 Total cost $9,738,000 Zazoo s labor efficiency variance for the year is
SU 10.4 Question 2 (cont.) Zazoo s labor efficiency variance for the year is A. $100,000 unfavorable. B. $238,000 unfavorable. C. $380,000 favorable. D. $500,000 favorable
SU 10.4 Question 2 Answer Correct Answer: A The labor efficiency variance is the standard cost per hour times the difference between standard and actual hour. The standard labor rate is $50 per hour, and the standard time allowed for 9,500 articles is 190,000 hours (9,500 20). Actual hours worked totaled 192,000. Thus, an unfavorable variance of 2,000 hours occurred. The unfavorable labor efficiency variance is therefore $100,000 (2,000 hours $50). Incorrect Answers: B: The difference between the standard labor cost ($9,500,000) and total actual (fixed + variable) cost ($9,738,000) is $238,000. C: The variance is unfavorable. D: The efficiency variance is based on standard hours for actual production levels--in this case, 190,000 hours.
Conclusion key take away What could explain favorable / unfavorable variances? Better purchase price (supplier concentration) Lower quality input (outsource other country) Better technology = more efficiency (turnaround, bottleneck) Higher-skilled workers (PhD, training, turnover, benefits, union) Less scrap / spoilage = Lean sigma (waste) Economies of scale (volume) Inflation cost of living (tax, insurance, rent) Cost of capital, risk, exchange rate External factors (competitors, demand, distribution) Components of the product (spare parts)