Performance Evaluation Using Variances From Standard Costs

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Performance Evaluation Using Variances From
Standard Costs
Revised by Judy Beebe, Western Oregon University

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Standards
Standards are performance goals. Manufacturers
normally use standard costs for each of the three
manufacturing costs

• Direct materials
• Direct labor
• Factory overhead

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Accounting systems that use standards for direct
materials, direct labor, and factory overhead are
called standard costs systems.
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When actual costs are compared with standard
costs, only the exceptions or variances are
reported for cost control (called reporting by
the principle of exceptions).
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Setting Standards

• The standard-setting process normally requires
  the joint efforts of accountants, engineers, and
  other management personnel.

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Types of Standards
Unrealistic standards that can be achieved only
under perfect operating conditions (such as no
idle time, no machine breakdowns, no materials
spoilage) are called ideal standards or
theoretical standards.
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Currently attainable standards or normal
standards can be attained with reasonable effort.
Standards set at this level allow for
disruptions, such as material spoilage and
machine breakdowns.
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Reviewing and Revising Standards
Standard costs should be continuously reviewed
and should be revised when they no longer reflect
operating conditions.
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Critics of Using Standards
Critics of standards believe the following

• Standards limit operating improvements by
  discouraging improvements beyond the standard.
• Standards are too difficult to maintain in a
  dynamic manufacturing environment, resulting in
  stale standards.

(Continued)
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Critics of Using Standards

• Standards can cause workers to lose sight of the
  larger objectives of the organization by focusing
  only on efficiency improvements.

• Standards can cause workers to unduly focus upon
  their own operations to the possible harm of
  other operations that rely on them.

(Concluded)
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Standard Cost for XL Jeans
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Budget Performance Report
The budget performance report summarizes the
actual costs, the standard amounts for the actual
level of production achieved, and the differences
between the two amounts (called cost variances).
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A favorable cost variance occurs when the actual
cost is less than the standard cost (at actual
volumes).
An unfavorable cost variance occurs when the
actual cost exceeds the standard cost (at actual
volumes).
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Budget Performance Report
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Relationship of Variances to the Total
Manufacturing Cost Variances
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Direct Materials
Standard square yards per pair of
jeans 1.50 sq. yards Actual units produced x
5,000 pairs of jeans Standard square yards of
denim budgeted for actual
production 7,500 sq. yards Standard price per sq.
yd. x 5.00 Standard direct materials cost at
actual production 37,500
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Direct Materials Price Variance
Actual price per unit 5.50 per sq. yd. Standard
price per unit 5.00 per sq. yd. Price variance
(unfavorable) 0.50 per sq. yd.
0.50 times the actual quantity of 7,300 sq. yds.
3,650 unfavorable
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Direct Materials Quantity Variance
Actual quantity used 7,300 sq. yds. Standard
quantity at actual production 7,500 Quantity
variance (favorable) (200) sq. yds.
(200) square yards times the standard price of
5.00 (1,000) favorable
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Direct Materials Variance Relationships
Actual cost
Standard cost
Standard quantity x Standard price 7,500 x 5.00
37,500
Actual quantity x Standard price 7,300 x 5.00
36,500
Actual quantity x Actual price 7,300 x 5.50
40,150
Materials price variance
Material quantity variance
3,650 U
(1,000) F
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Direct Materials Variance Relationships
Actual cost
Standard cost
Total direct materials cost variance
2,650 U
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Tip Top Corp. produces a product that requires
six standard pounds per unit. The standard price
is 4.50 per pound. If 3,000 units required
18,500 pounds, which were purchased at 4.35 per
pound, what is the direct materials (a) price
variance, (b) quantity variance, and (c) cost
variance?
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• Direct materials price variance (favorable)
• (2,775) (4.35 4.50) x 18,500 pounds

• Direct materials quantity variance (unfavorable)
• 2,250 (18,500 pounds 18,000 pounds) x
• 4.50

• Direct materials cost variance (favorable)
• (525) (2,775) 2,250 or(4.35 x 18,500
  pounds) (4.50 x 18,000 pounds) 80,475
  81,000

For Practice PE22-1A, PE22-1B
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Direct Labor Variances
Standard direct labor hours per pair of XL
jeans 0.80 direct labor hour Actual units
produced x 5,000 pairs of jeans Standard direct
labor hours budgeted for actual production
4,000 direct labor hours Standard rate per DLH x
9.00 Standard direct labor cost at actual
production 36,000
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Direct Labor Rate Variance
Actual rate 10.00 Standard rate 9.00 Rate
varianceunfavorable 1.00 per hour
1.00 times the actual time of 3,850 hours
3,850 unfavorable
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Direct Labor Time Variance
Actual hours 3,850 DLH Standard hours at
actual production 4,000 Time
variancefavorable (150) DLH
(150) Direct labor hours times the standard rate
of 9.00 (1,350) favorable
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Direct Labor Variance Relationships
Actual cost
Standard cost
Actual hours x Standard rate 3,850 x 9.00
34,650
Actual hours x Actual rate 3,850 x 10
38,500
Standard hours x Standard rate 4,000 x 9.00
36,000
Direct labor rate variance
Direct labor time variance
3,850 U
(1,350) F
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Direct Labor Variance Relationships
Actual cost
Standard cost
Total direct labor cost variance
2,500 U
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Tip Top Corp. produces a product that requires
2.5 standard hours per unit at a standard hourly
rate of 12 per hour. If 3,000 units required
7,420 hours at an hourly rate of 12.30 per hour,
what is the direct labor (a) rate variance, (b)
time variance, and (c) cost variance?
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• Direct labor rate variance (unfavorable)
• 2,226 (12.30 12.00) x 7,420 hours

• Direct labor time variance (favorable)
• (960) 7,420 hours 7,500 hours) x 12.00

• Direct labor cost variance (favorable)
• (1,266) 2,226 (960) or (12.30 x
  7,420 hours) (12.00 x 7,500 hours) 91,266
  90,000

For Practice PE22-2A, PE22-2B
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Factory Overhead Cost Budget Indicating Standard
Factory Overhead Rate
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Variances from standard for factory overhead
result from
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The Factory Overhead Flexible Budget

• 1. Actual variable factory overhead cost greater
  or less than budgeted variable factory overhead
  for actual production.
• 2. Actual production at a level above or below
  100 of normal capacity.

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Variable Factory Overhead Controllable Variance
Actual variable factory overhead
10,400 Budgeted variable factory overhead for
actual amount produced (4,000 hrs. x 3.60)
14,400 Controllable variance
favorable (4,000) F
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Tip Top Corp. produced 3,000 units of product
that required 2.5 standard hours per unit. The
standard variable overhead cost per unit is 2.20
per hour. The actual variable factory overhead
was 16,850. Determine the variable factory
overhead controllable variance.
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350 unfavorable 16,850 2.20 x (3,000 units
x 2.5 hours)
For Practice PE22-3A, PE22-3B
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Fixed Factory Overhead Volume Variance
100 of normal capacity 5,000 direct labor
hours Standard hours at actual production
4,000 Capacity not used 1,000 direct labor
hours Standard fixed overhead rate x 2.40 Volume
varianceunfavorable 2,400 U
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Tip Top Corp. produced 3,000 units of product
that required 2.5 standard hours per unit. The
standard fixed overhead cost per unit is 0.90
per hour at 8,000 hours, which is 100 of normal
capacity. Determine the fixed factory overhead
volume variance.
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450 unfavorable 0.90 x 8,000 hours (3,000
units x 2.5 hours)
For Practice PE22-4A, PE22-4B
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Reporting Factory Overhead Variances
Total actual factory overhead 22,400 Factory
overhead applied (4,000 hours x 6.00 per hour)
24,000 Total factory overhead cost
variancefavorable (1,600) F
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Factory Overhead Cost Variance Report
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Factory Overhead Variances and the Factory
Overhead Account
Factory Overhead
Actual factory overhead 22,400
Applied factory overhead 24,000
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Factory Overhead Variances and the Factory
Overhead Account
Overapplied factory overhead
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Applied Factory Overhead 24,000
Actual Factory Overhead 22,400
Volume Variance
Controllable Variance
(4,000) F
2,400 U
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Applied Factory Overhead 24,000
(1,600) F
Total Factory Overhead Cost Variance
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Recording and Reporting Variances from Standards
Western Rider Inc. purchased, on account, the
7,300 square yards of blue denim at 5.50 per
square yard. The standard price was 5.00.
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Western Rider Inc.s Purchase of Materials Entry
Materials (7,300 sq. yds. x 5.00) 36 500
00 Direct Materials Price Variance 3 650 00
Accounts Payable (7,300 sq. yds. x 5.50)
40 150 00
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Western Rider Inc. used 7,300 square yards of
blue denim to produce 5,000 pairs of XL jeans,
compared to the standard of 7,500 square yards.
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Work in Process (7,500 sq. yds. x 5) 37
500 00
Direct Materials Quantity Variance 1 000 00
Materials (7,300 sq. yds. X 5) 36 500 00
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Tip Top Corp. produced 3,000 units of product
that required six standard pounds per unit at
4.50 standard price per pound. The company
actually used 18,500 pounds in production.
Journalize the entry to record the standard
direct materials used in production.
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Work in Process 81,000 Direct Materials
Quantity Variance 2,250 Materials 83,250
(18,500 pounds 18,000 pounds) x 4.50,
unfavorable debit
For Practice PE22-5A, PE22-5B
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Variances from Standards in Income Statement
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Prepare an income statement for the year ended
December 31, 2008 through gross profit for Tip
Top Corp. using the variance data in Example
Exercise 23-1 through Example Exercise 23-4.
Assume Tip Top sold 3,000 units at 100 per unit.
Click for EE 22-3
Click for EE 22-1
Click for EE 22-2
Click for EE 22-4
To return to this slide, type 52 and press
Enter.
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TIP TOP CORP. INCOME STATEMENT THROUGH GROSS
PROFIT For the Year Ended December 31, 2008
Sales (3,000 units x 100) 300,000 Cost of goods
soldat standard 194,250 Gross profitat
standard 105,750
(Continued)
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Follow My Example 22-6 (continued)
Gross profitat standard (from Slide 53) 105,750
For Practice PE22-6A, PE22-6B
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Nonfinancial Performance Measures
A nonfinancial performance measure is a
performance measure expressed in units other than
dollars.
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Nonfinancial Performance Measures

• Inventory turnover

• Percent on-time delivery
• Elapsed time between a customer order and product
  delivery
• Customer preference rankings compared to
  competitors
• Response time to a service call
• Time to develop new products
• Employee satisfaction
• Number of customer complaints

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Nonfinancial Performance Measures for the Counter
Service Activity of a Fast Food Restaurant
Inputs Employee training Employee
experience Number of new menu items Number of
employees Fryer reliability Fountain supply
availability
Outputs Line wait Percent order accuracy Friendly
service score
Activity Counter service
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The following are inputs and outputs to the
baggage claim process of an airline.
Baggage handling training Time customers wait for
returned baggage Maintenance of baggage handling
equipment Number of baggage handlers Number of
damaged bags On-time flight performance
Identify whether each is an input or an output to
the baggage claim process.
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Baggage handling training Time customers wait for
returned baggage Maintenance of baggage handling
equipment Number of baggage handlers Number of
damaged bags On-time flight performance
Input Output Input Input Output Input
For Practice PE22-7A, PE22-7B