This Document Contains Chapters 16 to 17 Chapter 16 Standard Costing, Variance Analysis, and Kaizen Costing Chapter Outline A. Cost Management Challenges — Chapter 16 offers four cost management challenges. 1. How are standards set for production activities when a company uses standard costing? 2. What are variances, and how can different variances be interpreted? 3. Who is in the best position to control and manage different variances? 4. What are some valid criticisms made about standard-costing systems as they are used in today’s business environment? B. Learning Objectives — This chapter has ten learning objectives. 1. Chapter 16 discusses how companies use standard-costing systems to manage costs and describes two ways to set standards. 2. The chapter defines and distinguishes between perfection and practical standards. 3. It shows how to compute and interpret direct-material price and quantity variances, and direct-labor rate, and efficiency variances. 4. Chapter 16 describes several methods for determining the significance of cost variances. 5. The chapter discusses the behavioral effects of standard costing and discusses the controllability of variances. 6. It explains how companies use standard costs in product costing. 7. It summarizes some advantages attributed to standard costing. 8. Chapter 16 describes the changing role of standard-costing systems in today’s manufacturing environment. 9. It explains the concept of kaizen costing and its potential benefits. 10. The appendix shows how to compute and interpret production mix and yield variances. C. Every control system has three parts: a standard performance level, a measure of actual performance, and a comparison between the two. A cost manager may use a standard costing system in that way. Standards are set, and actual performance is measured and then compared to the standard. 1. A standard cost is established for completion of one unit of product. The difference between a standard cost and the actual cost of one unit is called a cost variance. 2. Managers do not investigate every single variance that occurs. The process of investigating only significant variances is called management by exception. 3. Standards are set using one of two approaches — analysis of historical data or task analysis. a. One simple way to set standards is to simply look at the costs that occurred in the past. Using this approach, while simple, has some drawbacks. First, if there are inefficiencies in production activities, they are included in the standard. Second, if any changes in production processes occur, the standard may become obsolete. Third, historical data does not exist for new products, so this approach will not work. b. Task analysis can be used to establish standards. This approach requires that the process of manufacturing a product determines what it should cost. c. Cost managers might use both historical data and task analysis to set standards. This is especially useful when parts of the production process are changed. d. Standard-setting may be accomplished with input from accountants (historical cost data), production supervisors, and production engineers (task analysis and actual quantities). 4. There are two views of how standards should be set. One view is that standards should be based on the assumption that perfection can be achieved. The other is that standards should be practical. a. Perfection standards can be attained only when no mistakes are made. Everything must operate perfectly. Many people believe that perfection standards discourage employees, since they don’t believe they can reach these standards. b. Practical standards are expected to be attainable. They are set, based on normal (not perfect) operating conditions. 5. Non-manufacturing organizations also use standards. Standards are set for length of time a service call takes; actual time taken to process a federal tax return is benchmarked against a standard; some McDonald’s Restaurants guarantee that a breakfast order will be ready in 90 seconds or less. 6. Standard costing systems help managers to control costs. Developing, implementing, and maintaining a standard cost system requires a commitment on the part of management, because the standards must be evaluated regularly, and the information it generates is only of value if it is used. The system is used to perform variance analysis. D. Variance analysis is a comparison of expected outcomes, based on standards, to actual outcomes. This comparison is what variance analysis is. Variances arise for each different type of resource used in an organization. In a manufacturing environment, variances are identified for resources used in production. Two resources for which variance analysis has traditionally been completed are direct materials and direct labor. 1. There are two standards related to direct materials. The first is standard quantity. This standard quantity is the amount that is expected to be used to make one unit of product. The second standard is the standard price. Standard price is the estimated cost per unit of input. Any shipping or delivery costs are added, and any purchase discounts are subtracted to derive the standard cost. 2. There are two direct labor standards. One is the direct labor quantity standard, and it is the estimated direct labor time needed to manufacture one unit of product. The standard direct labor rate is the total hourly cost of labor, including fringe benefits. 3. The standard costs for materials and labor are both based on considering quantity and unit cost of inputs. When actual production occurs, the amount of cost assigned to the units is assigned based on standards. Suppose 500 units were made, and the standard quantity allowed is 10 pounds of material at a standard price of $4 per pound. Then, a total of 500 times 10 pounds times $4 per pound, or $20,000 would be assigned to the inventory account for materials. 4. After actual production activity is complete and direct materials and labor costs have been determined, the next step is to see how actual cost outcomes varied from the standards. The differences are broken into different types of variances because there are different underlying causes for the variances. 5. There are two variances related to direct materials. They are the direct material price variance and the direct material quantity variance. a. The direct material price variance compares the actual cost of materials purchased to the standard price of materials purchased. A formula to express this variance is: Direct material price variance = (PQ*AP) – (PQ*SP), or PQ * (AP–SP) where PQ = quantity purchased AP = actual price per unit SP = standard price per unit b. The direct material quantity variance compares the standard cost of the actual quantity of materials used to the standard cost of the standard quantity that should have been used. The formula to express this variance is: Direct material quantity variance = (AQ*SP) – (SQ*SP), or SP * (AQ–SQ) where AQ = actual quantity used SP = standard price per unit SQ = standard quantity allowed c. A cost variance is unfavorable if actual costs are higher than the standard allows, and they are favorable if actual costs are lower than the standard allows. If the actual price is higher than the standard price, then the price variance will be unfavorable. If the actual quantity used is higher than the standard quantity allowed, then the variance will be unfavorable. d. The direct material price variance is based on the actual quantity purchased. The direct material quantity variance is based on the actual quantity of materials used to make the actual number of units produced. The price variance is related to the purchasing function of an organization. The quantity variance is related to production activities. e. In the case where direct materials are purchased in a country that uses different currency than the home country’s currency, there may be a variance that is due entirely to the foreign currency exchange rate. If there are foreign currency exchange rate differences, this piece of the direct material price variance should be separated from the price variance that is normally calculated. 6. There are two variances related to direct labor. They are the direct labor rate variance and the direct labor efficiency variance. a. The direct labor rate variance is related to differences between the standard hourly labor rate and the actual hourly labor rate. The formula for the direct labor rate is: Direct labor rate variance = (AH*AR) – (AH*SR) or AH*(AR-SR) where AH = actual hours used AR = actual rate per hour SR = standard rate per hour b. The direct labor efficiency variance is related to the differences between the standard labor time allowed for the actual units produced and the actual time taken to make the units produced. The direct labor efficiency variance is: Direct labor efficiency variance = (AH*SR) – (SH*SR) or SR*(AH-SH) where AH = actual hours used SH = Standard hours allowed for actual output SR = standard rate per hour c. The total direct labor variance is the sum of the rate variance and the efficiency variance. The total direct labor variance can be calculated directly by using the following formula: Direct labor variance = (AH*AR) – (SH*SR) 7. When there are multiple types of direct materials or different classes of direct labor, variances must be computed for each one. Additional variances may be caused by using combinations of inputs that are different from the standard combinations of inputs. These are referred to as mix and yield variances and are explained in the appendix to Chapter 16. 8. Most production processes have some defects or spoilage. If this is a normal part of the production process, then these amounts and costs must be factored into the standard quantities of materials E. Cost variances of many types and dollar amounts are possible. Managers cannot investigate every single variance that occurs. Since standards are not perfect; it is not expected that actual outcomes will perfectly match standards. Management by exception requires that managers look only at variances that are significant. The question then becomes what is a “significant” variance? There are a number of guidelines that help managers determine when a variance might need to be investigated. 1. The size of a variance is one determinant of significance. The relative size should be considered. This means a variance should be considered in comparison to the total cost. A $50,000 direct material quantity variance for the entire Coca-Cola Company’s production of Sprite would probably be considered insignificant. A $50,000 direct material quantity variance for a small independent soft drink bottler whose total direct materials cost is $500,000 would be quite significant. Some companies use a combination of absolute and relative amounts by instituting a policy that says something like, “investigate any variance over $100,000 or any variance that exceeds 5% of standard cost.” 2. The frequency of a variance should also be a basis for deciding whether a variance needs to be investigated. If a variance occurs on a regular basis, it could either mean that a process is out of control, or it could mean that the standard has been misestimated. A recurring variance should be investigated even if its size does not warrant investigation. 3. A trend in the variance is often a warning sign of a process that is going out of control. A variance that is moving in an upward or downward direction consistently is usually a sign that it will become significant anyway in the future. An astute manager will recognize the trend, investigate it early, and correct the problem. 4. A variance is more likely to be investigated if a cost manager believes it is controllable. If a variance is occurring because of events that cannot be controlled, there is little point in investigating it since it cannot be corrected. 5. A favorable variance is often viewed as a good thing, because it means that costs are less than expected. However, favorable variances that are outside an acceptable range should be investigated just as unfavorable ones should be. a. A favorable variance may be occurring because of true efficiencies or improvements in production activities. Managers need to understand them so that future standards can be modified and so that any improved efficiencies can be adapted to other production activities. b. A favorable variance might also mean that some important input is being used too sparingly. Suppose, for instance, that there was a favorable direct labor efficiency variance for the construction of roller coasters. If the variance was favorable because workers were skipping steps needed to ensure that the ride would be safe, the variance would be very unfavorable in the long run. 6. One final consideration in deciding whether to investigate a variance is the benefit that might be derived from the investigation (compared to the cost of investigation). 7. Once a variance is identified as significant, it is then important to try to identify the causes of the variance. A statistical control chart can help managers to separate random variation in productive levels from actual problems. A statistical control chart is used to identify variances that exceed some critical value. Often this critical value is one standard deviation or a multiple of the standard deviation. F. Standard costing has some effects on the behavior of managers and other employees. Many organizations reward employees for achieving standards or for performing at a level that is lower than the cost standard. In some cases this may motivate the correct behavior. Employees may actively seek ways to operate in an efficient, economical way. Unfortunately, using standards to evaluate and reward employees may also motivate employees to cut corners that should not be cut. Buying lower quality materials to save money on material costs, or using less than standard amounts to generate favorable materials quantity or labor efficiency variances, could affect product quality. That type of behavior, in the long run, affects customer loyalty and might even affect company reputation. G. Different variances are controllable by different managers. The person who is most able to influence a particular variance can often be identified and be given the responsibility for managing and controlling the amount of variance. 1. The direct materials price variance is the responsibility of the purchasing manager. This individual can avoid unfavorable direct material price variances by ordering materials in bulk, when practical, to take advantage of purchase discounts. At the same time, buying too much leads to higher inventory costs, so the value of purchase discounts should exceed the cost of having extra inventory on hand. Timely ordering of raw materials should also minimize shortages, costly expedited delivery, and production bottlenecks, which can all be costly events. If the production manager informs the purchasing manager of materials needs too late, the purchasing manager might not be able to control the related costs of expedited shipping and bottlenecks. These two managers must work together to coordinate materials purchase activities. 2. The direct material quantity variance and both direct labor variances (rate and efficiency) are the responsibility of the production manager. The production manager should see that there is minimal waste. Material quantity variances may also occur if technical specifications call for inferior materials. This could lead to more waste or higher numbers of defects or reworked units. The production manager may be responsible for reporting on the variances that result, but the production engineers who develop the specifications may be the people who have caused the variance. The direct labor rate variance may be caused by the mix of experienced or inexperienced workers. The production supervisor must schedule employees’ work in accordance with the labor standards to avoid labor rate variances. In an environment where employees are a constrained resource, the supervisor may not always have the luxury of scheduling to avoid variances. Direct labor efficiency variances can be managed by having the correct mix of skill levels of employees and by motivating employees to achieve production goals. 3. In many cases there are interactions among variances. Buying inferior materials may cause a favorable direct material price variance. However, the inferior quality may lead to an increase in materials needed for each unit, causing a direct material quantity variance. Having more experienced employees work on product may cause a favorable direct labor efficiency variance. Yet, using this more expensive group of workers may cause an unfavorable direct labor rate variance. 4. By looking at variances from a value-chain perspective, managers can see that the effect of one variance is to cause another variance someplace else. Upstream activities and decisions can have positive or negative effects on downstream activities or outcomes. Unfavorable variances in the production area, for instance, may be due to poor decisions made in the design or supply portions of the value chain. H. A standard costing system is not used only to manage and control costs. It is also used to assign costs to units of product. Accounting for product costs under a standard costing system is accomplished by assigning only standard costs to units of product and then by using separate accounts to record variances. Accounts are created for direct material price and quantity variances, and accounts are created for direct labor rate and efficiency variances. 1. The flow of product costs in a manufacturing firm is reviewed briefly. Direct materials, direct labor, and manufacturing overhead costs are charged to the work-in process inventory account. When a standard cost system is in place, only the standard costs are charged to WIP. When production is complete, the standard cost for completed units is transferred from WIP to finished goods inventory. When product is sold, the amounts in finished goods are transferred to cost of goods sold, which is subsequently closed to an income summary account. a. The direct material price variance occurs when materials are purchased. Raw materials inventory is debited for the standard cost of materials purchased. If the price variance is unfavorable, it is treated like a cost, and the direct materials price variance is debited. If the variance is favorable, it is treated as a reduction of a cost, and the variance account is credited. b. The direct material quantity variance occurs when production activities take place. Work-in process is debited for materials costs at the standard cost for actual production completed. The difference between the cost of the standard quantity of materials allowed and the standard cost of materials used is the materials quantity variance. This variance is, like the price variance, treated as a cost if it is unfavorable and is treated like a cost reduction if it is favorable. c. The direct labor rate variance is isolated in a fashion similar to the direct material price variance. The direct labor efficiency variance is isolated in a fashion similar to the direct material quantity variance. Since both of these variances occur during production, they are recorded in the costing system at the same time. d. Variance accounts are treated like expense accounts and are closed at the end of each accounting period. Most companies close out variances to cost of goods sold. If the net amount of variance is favorable, cost of goods sold will be reduced. If unfavorable, then cost of goods sold will be increased. An alternative way to dispose of variances is to prorate them among work-in process, finished goods inventory, and cost of goods sold. This alternative approach reflects the effects of inefficiency or efficiency in all the accounts through which the manufacturing costs flow. I. Standard costing systems can use information technology to link together several business processes. Standard cost information is loaded onto a computerized costing system. When materials are placed into production, the computerized information system assigns materials costs, at standard cost, to work in process. The same thing happens with labor costs. That way, units of product are not contaminated by assignment of costs that are not standard. Use of bar codes and computer-aided design has increased the efficiency of the costing system in manufacturing firms. 1. Bar codes are used to monitor, control, and record the costs of product inputs. When raw materials are purchased and received, they are bar coded. That is, a computer generates an identification tag and the materials are labeled. When materials are sent to production, they are scanned as they leave the raw materials inventory warehouse and are automatically deducted from raw materials inventory. The materials are then assigned to work-in process. Bar-coding can also be used to assign direct labor costs to a job. 2. Standard costing systems may be integrated with computer-aided design (CAD) systems to assist design engineers in the product design process. This enables product designers to obtain standard cost information, which helps them to determine the cost of new products. J. Standard costing, which has a long history of use in manufacturing has several advantages. Standard costing is credited for (1) enabling managers to employ management by exception, which conserves management time; (2) providing sensible cost comparisons between benchmarks and actual outcomes; (3) providing a basis for evaluating and rewarding employees for performance; (4) motivating employees to adhere to standards; (5) giving product costs stability not possible if actual costs are used; and (5) providing a costing system that is often less expensive than an actual or normal-costing system. K. While standard costing has been widely accepted and adopted by many organizations, it has been criticized in recent years for several reasons. There are disadvantages to use of the traditional standard costing system. Others argue that standard costing can be adapted to fit modern management philosophies. 1. Standard costing has been criticized for the following reasons. a. Variances calculated are too aggregated and come too late to be useful. Critics argue that variances should be based on the many activities that occur in an organization. Traditional standard costing also ignores modern management issues such as product quality, processing time, elimination of non-valueactivities, and delivery performance. b. Traditional standard cost variances are not disaggregated along product lines, batches, or flexible-manufacturing-cells. This makes it difficult for managers to determine the cause of variances. c. Traditional systems place too much emphasis on direct labor costs and efficiency. Direct labor is becoming a relatively unimportant factor of production. d. Standard costing is based on relatively stable production processes. Modern production processes often contain necessary elements of flexible manufacturing systems that allow frequent switching among a variety of products on the same production line. e. Standards are only relevant for a short time if a product has a short life cycle. f. Standard costing focuses exclusively on cost minimization, ignoring product quality and customer service. g. Variances from standards tend to be very small (insignificant) in highly automated manufacturing processes. h. Traditional standard costing systems tend to be too broadly defined and may ignore some of the costs of resources like direct materials. i. Standard costing is historically oriented and is not forward looking. 2. Despite the criticisms just listed, some critics argue that standard costing systems can be modified to be compatible with modern management needs. The following adaptations might make standard costing a viable costing system, even in a modern manufacturing environment. a. Variances focused on direct labor standards should be minimized, as they are losing their relevance. Machine hours, product quality, manufacturing cycle times, and support-department costs have become more important cost control issues than direct labor. b. Instead of focusing on direct labor, standard costing systems should shift the emphasis to material and overhead costs, and quality management must be incorporated into the standards. c. Cost-driver analysis should be the unit of analysis rather than units of product or units of input. Use of cost drivers like machine hours, number of parts, and production runs may be more informative than number of direct labor hours. d. Cost structures are changing so that unit-level costs like direct material and direct labor are becoming less important, and overhead costs are becoming more important. e. Total quality management (TQM) and JIT approaches place emphasis on high quality and minimization of costs via reduction of waste and rework. Standard costing can be modified to look for variances from quality standards or rework levels. f. Standard costing systems need to be modified to aid in efforts to eliminate nonvalue-added costs. Standards should not be set at levels that allow non-valueadded activities to be factored in. g. Standards must be revised more frequently for products that have short life cycles. h. Standard costing should not be the only tool used to evaluate performance. Nonfinancial measures must also be used to evaluate outcomes. i. Benchmarking of processes by comparing them to other units in an organization, or comparing them to other organizations, should be used in addition to benchmarking against standards. j. Computer-integrated manufacturing (CIM) often provides the manager with immediate feedback on actual costs and activities. This allows a quick response to unfavorable variances. L. Standard costing is used not only for cost control but also for recording relevant accounting transactions. The best practice is to journalize at the point of isolating the variance. For example, the entry is made for materials purchased by debiting raw material inventory at the standard cost of the material, crediting accounts payable at actual cost and charging the difference to a materials price variance account. Variances are written off to cost of sales if minimal. Otherwise, they may be prorated to cost of sales, work in process inventory, and finished goods inventory based on balances in those accounts. Under a standard costing system, raw materials, work in process, and finished goods inventory are always kept at standard prices. M. Kaizen costing is the process of cost reduction during the manufacturing phase of a product. When kaizen costing is used, improvements occur in small steps. Every employee is responsible for looking for ways to improve production processes and reduce unnecessary costs. Kaizen goals are set based on actual results from the prior year. The goal is to reduce actual costs from the current year in the coming year. N. Direct material usage variance may be broken down into two components of direct material mix variance and direct material yield variance. These variances may be computed when the product requires the mixture of two or more ingredients. 1. Direct material mix variance for a particular direct material is the difference between the actual and standard input proportions for that material multiplied by that material’s standard price and multiplied by the actual total quantity of all direct materials used. 2. Direct material yield variance for a particular material is the difference between the actual quantity of all direct materials used and the standard quantity of all direct materials, given actual output, multiplied by that particular direct material’s standard price and multiplied by that direct material’s standard input proportion. 3. The combination of mix and yield variance tell us not only the over or under usage of materials but also whether the ingredients were used in proportions that the standard calls for or in some other way. Problem 1 – Chapter 16 Learning objective 3, 8, and 10 Comprehensive variance analysis Time required: 45 minutes Omid Company makes the product X that has two ingredients Y and Z. The company uses a JIT system and buys the materials as needed. The standard calls for using 3 lbs of Y and 2 lbs of Z for each unit of X at $9 and $6 a lb respectively. A total of 900 units of X were produced. A total of 3,150 lbs of Y was bought for $27,090, and a total of 1,620 lbs of Z was purchased for $10692. All materials were used. Required: Determine a) material price variance, b) material efficiency variance, c) material mix variance, d) material yield variance, and e) make the appropriate journal entries and close the variances to cost of goods sold. Item Output Qty Price Total std Qty Actual $ Variance Price Var. Eff. Var. Mix Var. Yield Var. Y 900 3 9 24300 3150 27090 -2790 1260 -4050 -2592 -1458 Z 900 2 6 10800 1620 10692 108 -972 1080 1728 -648 Totals 900 35100 4770 37782 -2682 288 -2970 -864 -2106 Computation of mix variance for Y: 9 * ((3/5) – (3150/4770)* 4770 = $2,592 U. Computation of yield variance for Y: 9 * (4,500 – 4,770) * .60 = $1,458 U. e) Journal entries: Problem 2 LO : 3 and 6 Direct material price and efficiency variance Estimated time : 30 minutes Nahid Furniture Manufacturing Company uses 10 yards of fabric A in manufacture of its sofas and 6.5 yards of fabric B in manufacture of its love seats. The budgeted prices are $18 per yard for A and $13.50 for B. For the month of June 2008, 3,500 yards of fabric A and 2,800 yards of fabric B were purchased for $103,600. From this amount $67,200 was for fabric A. A total of 320 sofas and 290 love seats were manufactured in this time period. The actual usage amounted to 3,100 yards of fabric A and 2,030 yards of fabric B. Determine a) Compute material purchased price variance for A and B, b) Compute material usage variance for A and B, c) Compute material price variance for A and B (variance determined at the point of usage), d) Prepare journal entries based on a and b above. Solution: Description Output Actual Standard Variance Type Fabric A purchases 3,500.00 3,500.00 3,500.00 Price 19.20 18.00 1.20 Total cost 67,200.00 63,000.00 4,200.00 MPPV Sofa: Fabric A 320.00 3,100.00 3,200.00 (100.00) Price: Fabric A 18.00 18.00 18.00 Total cost 55,800.00 57,600.00 (1,800.00) MUV Sofa: Fabric A 3,100.00 3,100.00 3,100.00 Price 19.20 18.00 1.20 Total cost 59,520.00 55,800.00 3,720.00 MPV Fabric B purchases 2,800.00 2,800.00 2,800.00 Price 13.00 13.50 (0.50) Total cost 36,400.00 37,800.00 (1,400.00) MPPV Love seat: Fabric B 290.00 2,030.00 1,885.00 145.00 Price 13.50 13.50 13.50 Total cost 27,405.00 25,447.50 1,957.50 MUV Love seat: Fabric B 2,030.00 2,030.00 2,030.00 Price 13.00 13.50 (0.50) Total cost 26,390.00 27,405.00 (1,015.00) MPV Journals: DR CR Raw material inventory 100,800.00 MPPV (A) 4,200.00 MPPV (B) 1,400.00 Acounts payable 103,600.00 Work in process 83,047.50 MUV (B) 1,957.50 MUV (A) 1,800.00 Raw material inventory 83,205.00 Problem 3 LO: 3 and 6 Ariana Lamp Company Direct labor rate and efficiency variance Estimated time: 20 minutes Ariana Lamp Company uses two grades of labor. Grade one is budgeted at $9 an hour and grade two is budgeted at $13 an hour. Each lamp requires 2 hours of grade one and .5 hours of grade two labor. A total of 750 lamps were produced in January. Grade one labor for the period amounted to 1,450 hours, and grade two labor used amounted to 400 hours. Total payroll amounted to $19,600 of which $14,500 was for labor grade one. Compute a) labor rate variance for grade one and two, b) labor efficiency variance for grade one and two, and c) prepare the necessary journal entries. Solution: Item Output Actual Standard Variance Grade A labor 750 1,450.00 1,500.00 Rate 10.00 9.00 Total cost 14,500.00 13,500.00 1,000.00 LV Grade B labor 750 400.00 375.00 Rate 12.75 13.00 Total cost 5,100.00 4,875.00 225.00 LV Grade A labor 1,450.00 1,450.00 1,450.00 Rate 10.00 9.00 1.00 Total cost 14,500.00 13,050.00 1,450.00 LRV Grade B labor 400.00 400.00 400.00 Rate 12.75 13.00 (0.25) Total cost 5,100.00 5,200.00 (100.00) LRV Total Rate 19,600.00 18,250.00 1,350.00 LRV Grade A labor 1,450.00 1,500.00 (50.00) Rate 9.00 9.00 9.00 Total cost 13,050.00 13,500.00 (450.00) LEV Grade B labor 400.00 375.00 25.00 Rate 13.00 13.00 13.00 Total cost 5,200.00 4,875.00 325.00 LEV Total efficiency 18,250.00 18,375.00 (125.00) LEV Journal Entry DR CR Work in process 18,375.00 LRV(A) 1,450.00 LEV(B) 325.00 LRV(B) 100.00 LEV(A) 450.00 Wages payable 19,600.00 Sample Quiz 1. In the contemporary manufacturing environment, there is a. more emphasis on material and labor price and efficiency variance. b. more emphasis on quality products and customer satisfaction. c. more emphasis on throughput efficiency. d. All of the above. e. b and c Answer: e Learning Objective: 8 Use this data in conjunction with questions 2 through 5. Nahid Curtains makes two kinds of curtains. Curtain A uses nine yards of fabric and curtain B uses 5.5 yards. Fabric A is $16 per yard while B is $12. For the month of June 2000, 3,200 yards of A and 2400 yards of B were purchased for $79,200. From this amount $52,800 was for fabric A. A total of 310 curtain A’s and 340 curtain B’s were made in this time period. The actual usage amounted to 3,050 yards of A and 1,900 yards of B. 2. Material purchase price variance for A amounts to a. – $1,525 b. – $1,600 c. $1,600 d. $2,400 e. None of the above. Answer: b Learning Objective: 3 3. Material usage variance for B amounts to a. – $360 b. – $4,160 c. $375 d. $800 e. None of the above. Answer: a Learning Objective: 3 4. Material price variance (based on usage) for B amounts to a. – $1,525 b. – $1,600 c. $1,900 d. $2,400 e. None of the above. Answer: a Learning Objective: 3 5. The journal entry for material purchased, excluding variances, should a. debit accounts payable and credit work in process. b. debit inventory and credit accounts payable. c. debit work in process and credit inventory. d. debit inventory and credit work in process. e. None of the above. Answer: b Learning Objective: 3 Use this data to respond to questions 6 through 8. Saba typesetting uses two grades of labor. Grade one is budgeted at $8 an hour and grade two at $11 an hour. Each job requires 1.5 hours of grade one and .8 hours of grade two labor. Grade one labor for the period amounted to 1,100 hours and grade two amounted to 560 hours. Total payroll for wage employees amounted to $15,400. From this amount, $13,850 is for direct labor and, from this total, $8,250 is for grade one labor. A total of 685 jobs were processed in the period. 6. Labor efficiency variance for grade one labor is a. $132 b. $580 c. – $132 d. – $580 e. None of the above. Answer: d Learning Objective: 3 7. Labor rate variance for grade two labor amounts to a. – $30 b. $428 c. $550 d. $560 e. None of the above. Answer: d Learning Objective: 3 8. The journal entry for payroll (exclusive of variances) should a. debit manufacturing overhead for $1,550, work in process for $13,850, and credit payroll summary for $15,400. b. debit WIP for $15,400 and credit payroll summary for $15,400. c. debit payroll summary and credit WIP for $15,400. d. debit payroll expense for $15,400 and credit payroll summary for $15,400. e. None of the above. Answer: a Learning Objective: 3 Use the following data to respond to questions 9 through 13. Production of each unit of X requires 8 lbs. of M at a cost of $9 per lb. and 4 lbs. of N at $11.20 per lb. However, for production of 1,000 units of X 10,000 lbs. were used, 75% of which was for material M at a cost of $8 per lb. for M and $9 per lb. for N. 9. Material usage variance for M amounts to a. $4,500 b. $16,800 c. – $4,500 d. – $16,800 e. None of the above. Answer: 3 Learning Objective: 3 10. Material price variance for N amounts to a. – $5,500 b. – $7,500 c. $5,500 d. $7,500 e. None of the above. Answer: c Learning Objective: 3 11. Material yield variance for M amounts to a. $7,467 b. –$7,497 c. $9,330 d. $12,000 e. None of the above. Answer: d Learning Objective: 10 12. Material mix variance for N amounts to a. $7,467 b. –$7,497 c. $9,330 d. $12,000 e. None of the above. Answer: c Learning Objective: 10 13. Total mix variance amounts to a. $1,833 b. $12,833 c. $16,467 d. $19,467 e. None of the above. Answer: a Learning Objective: 10 14. Material yield variance is indicative of a. having used a higher or lower share of material times total actual usage times actual rates. b. having used a higher or lower share of materials times total standard usage times actual rates. c. having used a higher or lower share of materials times total actual usage times standard rates. d. total actual usage minus standard usage times standard share of material times actual rates. e. total actual usage minus standard usage times standard share of material times standard rates. Answer: e Learning Objective: 10 15. Criticisms of standard costing include which of the following: a. Variances are too aggregate and too late to be useful. b. Variances are not tied to specific product lines or flexible manufacturing system cells. c. Standard costing systems focus too much on direct labor. d. All of the above. e. a and c Answer: d Learning Objective: 8 16. Advantages attributed to standard costing often include a. standard costing enabling managers to employ management by exception. b. standard costing providing a basis for sensible cost comparisons. c. variances providing a means of performance evaluation. d. All of the above. e. a and b Answer: d Learning Objective: 8 17. When using mix variances, we often use a. its individual components for analysis. b. it in its totality for analysis. c. it in its totality only if variances are favorable. d. its individual components if variances are unfavorable. e. None of the above. Answer: b Learning Objective: 10 18. Standard cost may be used in a. job order costing or process costing. b. job order costing but not process costing. c. process costing but not job order costing. d. normal costing but not job order costing. e. actual costing but not process costing. Answer: a Learning Objective: 1 19. Which of the following factors should be considered when deciding whether to investigate a variance? a. magnitude of the variance and the cost of investigation b. trend of the variances over time c. likelihood that an investigation will eliminate future occurrences of the variance d. whether the variance is favorable or unfavorable e. a, b, and c Answer: e Learning Objective: 5 20. Which department is customarily responsible for an unfavorable labor efficiency variance? a. quality control b. purchasing c. engineering d. production e. personnel Answer: d Learning Objective: 5 21. Standard costing is often criticized because a. variances calculated are too aggregated b. it places too much emphasis on direct labor costs and efficiency c. it is based on stable production processes d. it focuses only on cost minimization e. all of the above. Answer: e LO: 7 22. Standard costing can become more useful if a. less emphasis is put on direct labor variances b. more emphasis is placed on direct material and overhead variances c. cost driver analysis becomes the focus d. more attention is paid to eliminating non-value-added costs e. all of the above Answer: e LO: 7 23. For standard costing to become more useful it should a. be revised more frequently when needed b. be in line with TQM and JIT requirements c. be used in conjunction with qualitative factors d. be supplemented with benchmarking tools e. all of the above Answer: e LO: 7 Chapter 17 Flexible Budgets, Overhead Cost Management, and ActivityBased Budgeting Chapter Outline A. Cost Management Challenges — Chapter 17 offers three cost management challenges. 1. How can a management team use a flexible budget to help manage overhead costs? 2. What are overhead variances, and how can they be interpreted? 3. How can management of overhead costs be improved? B. Learning Objectives — This chapter has eleven learning objectives. 1. Chapter 17 explains how cost managers use flexible budgets to control overhead costs. 2. The chapter shows how to prepare and interpret a flexible overhead budget. 3. It shows how overhead is applied to work-in process inventory when a standard costing system is used. 4. Chapter 17 discusses issues related to choosing activity measures for overhead budgeting and application. 5. The chapter demonstrates how to compute and interpret variable overhead spending and efficiency variances, as well as fixed overhead budget and volume variances. 6. It shows how to prepare and interpret an overhead cost performance report. 7. Chapter 17 illustrates journal entry preparation to record manufacturing overhead costs under a standard costing system. 8. The chapter explains why an activity-based flexible budget may provide more useful cost management information than a conventional flexible budget. 9. Appendix A shows how to prorate variances among work-in process inventory, finished goods inventory, and cost of goods sold. 10. Appendix B illustrates and explains backflush costing in a JIT environment. 11. Appendix C illustrates and explains how to compute sales variances. C. A flexible budget is a cost-management tool used by many companies to control overhead costs. A flexible budget is different from budgets presented in Chapter 15 in one important respect. A flexible budget is not based on one level of activity. A flexible budget for overhead costs is a detailed plan for controlling overhead costs that is relevant within the firm’s relevant range of activity. In order to recognize the way a flexible budget works, one must first understand that fixed overhead costs behave differently than variable overhead costs. This makes it necessary for the costs to be managed differently. Fixed overhead costs do not change as an organization’s activity changes. Depreciation on buildings or equipment is an example of fixed overhead costs. Variable overhead costs vary with production activity. 1. Since variable overhead costs vary with production activity and actual activity is not static, it is useful to have a flexible budget approach, which shows what total costs should be, given different amounts of budgeted activity within the relevant range. 2. A flexible budget can be easily adjusted to show what overhead costs should be at a given level of activity. Traditional flexible budgets use input levels of activity, like machine hours, to set standards. This approach is particularly useful when there are two or more products manufactured. A flexible budget can be based on standard allowed input, given actual output. 3. The flexible overhead budget is split into variable and fixed cost categories. A formula that shows how to derive total budgeted monthly overhead costs is: Total budgeted monthly overhead costs = (budgeted variable OH cost per activity unit * total activity units) plus total budgeted fixed OH cost per month. The variable overhead rate is obtained by estimating total variable cost and dividing it by estimated activity level. A commonly used activity is machine hours. By using this formula, total overhead costs can be estimated for any activity level. 4. Overhead costs are applied to work-in process inventory as part of product cost. In a standard costing system, overhead costs are applied based on standard hours allowed for actual output. 5. Common measures of activity to use as the allocation base are machine hours, directlabor hours, direct labor cost, total process time, and direct material cost. a. The activity measure should be chosen because it varies in a similar pattern to the way that variable overhead varies. b. Traditionally, direct labor hours have been used as an activity driver. As direct labor costs contribute less to production costs, it becomes less useful as an activity base to use for assigning overhead costs. With increased automation, machine hours or process time have become more informative activity bases. c. Dollar measures are occasionally used as activity bases, but there are dangers associated with the use of dollars. Dollar measures are subject to price-level changes, while hours or other quantities do not experience similar fluctuations. d. Information technology has simplified flexible budgeting. Once variable rates are determined, a flexible budget can be changed to generate a budget for any activity level. D. In actual normal costing, overhead is applied to work in process based on actual input measures such as, direct labor hours, machine hours, or direct material costs. In standard costing, overhead is applied to work in process based on standard hours allowed given an output level. Both in normal costing and standard costing, a predetermined (standard) overhead rate is used. E. Use of a standard costing system for overhead costs results in overhead cost variances. Variance analysis for overhead costs is broken into fixed and variable components. Variance analysis for overhead costs begins with a flexible budget and estimation of planned activity 1. Estimated fixed overhead costs must be known. The variable overhead rate must be known. The standard amount of activity allowed for each unit of product must be known. The actual total variable and fixed overhead costs must be known, and the actual quantity of the activity base must be known. The actual number of units must be known. 2. Variable overhead variances are split into two pieces. One is the variable overhead spending variance. The other is the variable overhead efficiency variance. a. The variable overhead spending variance compares actual spending for variable overhead as compared to the amount of spending that should have occurred, given the actual activity of the allocation base. The formula for calculating the variable overhead spending variance is : Variable OH spending variance = actual variable overhead – (AH * SVR), where AH = actual quantity of the activity base SVR = standard variable overhead rate b. The variable overhead efficiency variance compares the amount of variable overhead cost that should have occurred given the actual quantity of the allocation base to the amount of variable overhead cost that should have occurred given that the standard allowed quantity of the allocation base had been used. The formula for calculating the variable overhead efficiency base is: Variable OH efficiency variance = (AH*SVR) – (SH*SVR), or Variable OH efficiency variance = SVR*(AH – SH) where AH = actual quantity of the activity base (for example, machine hours) SH = standard machine hours SVR = standard variable overhead rate c. The variable overhead spending variance is unfavorable if actual variable overhead costs are higher than they should be, given the quantity of the activity base. The variable overhead efficiency variance is unfavorable if the quantity of the activity base is more than the standard quantity allowed for the actual output produced. Interpretation of overhead variances becomes troublesome because they are often not as straight forward as other variances. d. The amount of variable overhead applied to work-in process is based on actual number of units produced at standard cost per unit. e. The efficiency variance is simple to interpret. It measures the efficiency with which the activity base was used in production. If the activity used as the allocation base is machine hours, and actual machine hours exceeds the standard quantity of machine hours allowed for the actual output, then the efficiency variance will be unfavorable. Notice, this variance does not inform managers about the efficiency in the use of variable overhead items like electricity or indirect labor or materials. f. The variable overhead spending variance is less informative than the efficiency variance. It is caused by two things. First, it is caused by paying more, or less, for the various variable overhead items. Second, it is caused by using more, or less, of variable overhead items than should have been used for actual activity. This second reason is a measure of the efficiency in the use of variable overhead items. Since variable overhead items are pooled and then allocated based on one activity, it is virtually impossible to isolate specific causes of the spending variance. 3. There are two fixed overhead variances. One is the fixed overhead budget variance. The other is the fixed overhead volume variance. a. The fixed overhead budget variance is simply a comparison of actual fixed overhead costs and budgeted fixed overhead costs. The formula is: Fixed overhead budget variance = actual fixed overhead – budgeted fixed overhead. b. The fixed overhead volume variance is a comparison between budgeted fixed overhead costs and the amount of fixed overhead applied. The formula is: Fixed overhead volume variance = budgeted fixed overhead – applied fixed overhead. Applied fixed overhead is computed as the standard quantity allowed for actual output, multiplied by the fixed overhead rate. c. An unfavorable fixed overhead budget variance can be interpreted simply as actual fixed overhead costs being higher than originally expected. The fixed overhead volume variance highlights the two different purposes of the costaccounting system. The cost-management purpose of a cost accounting system recognizes that fixed overhead cost does not change as production activity changes. Budgeted fixed overhead is the basis for controlling fixed overhead because it is the benchmark for comparing actual expenditures. The second purpose of a cost accounting system is product costing. The predetermined fixed overhead rate is used to apply fixed overhead costs to workin process inventory. d. An incorrect interpretation of an unfavorable volume variance is that it measures the cost of under-utilizing productive capacity. What an unfavorable volume variance does imply is that fewer products were produced than were budgeted. The “cost” is lost contribution margin from units of product not produced for sale. This “cost” may be due to a conscious decision on the part of management to produce less because of lowered demand expectations. 4. The four variances described so far — variable overhead spending variance, variable overhead efficiency variance, fixed overhead budget variance, and fixed overhead volume variance — can be combined into two or three variances. Some analyses may combine the variable overhead spending variance with the fixed overhead budget variance, calling this a spending variance. In this case, there are three variances — the overhead spending variance, the variable overhead efficiency variance, and the fixed overhead volume variance. Some analyses combine the variable overhead spending variance, variable overhead efficiency variance, and the fixed overhead budget variance, calling this variance the budget variance. In this two-way analysis, there is a budget variance and a fixed overhead volume variance. F. An overhead cost performance report is used to summarize the budgeted and actual costs and activities and to compare them by showing the variances. To the extent possible, specific overhead items are presented separately, so that managers can identify, investigate, and explain significant variances for specific inputs. G. Standard cost systems allow product costs to be assigned based on standards instead of using actual costs. Just as standard costs are assigned for direct materials and direct labor, they are assigned for fixed and variable overheads, using the standard rates and standard quantities of the activity base. The flow of costs through the accounting system is outlined below. 1. Actual manufacturing overhead costs are assigned (debited) to the manufacturing overhead account. Various accounts are credited. At the end of the month, when production is completed and accounted for, costs for overhead are assigned using the standard cost per unit of product. Work-in process inventory is debited for the standard overhead cost, and the manufacturing overhead account is credited. If the amount of overhead applied is greater than the actual amount of overhead cost incurred, then overhead costs were overapplied. If the amount applied is less than actual overhead costs incurred, then overhead costs were underapplied. In either case, the over- or underapplied overhead costs are reflected in the four overhead variances. In other words, the sum of the four overhead variances will equal the over- or underapplied amounts. The variances are usually closed out to cost of goods sold. An alternative way to close the variances is to prorate them among work-in process, finished goods inventory, and cost of goods sold. This approach is explained in the appendix. H. The traditional standard costing system and flexible budgets can be modified to have multiple cost drivers instead of just one. Activity-based product costing can be used as the basis for flexible budget planning and management purposes. While the traditional standard costing system used one cost driver like machine hours, an ABC system would split costs according to their relation to machine hours, number of setups, number of production runs, or other activities. Overhead costs that might be fixed with respect to machine hours might vary with more appropriate cost drivers. An ABC flexible budget is more accurate in reporting costs and allows more accurate cost estimation during the budget process. The performance report would yield more informative variances that could be used to identify true reasons for the variances that occur. I. Appendix A explains the procedures for allocation of variances to work in process, finished goods inventory, and cost of goods sold accounts. The proration should be done based on material portion in the above accounts for material variances and labor and overhead balances for the remaining variances. This allocation is appropriate when the amount of variance is considered significant. Minimal amounts are usually charged directly to cost of sales. J. Appendix B explains backflush costing. Backflush costing is applicable in just-in-time inventory situations particularly with the use of standard costing. To simply record keeping, costs are originally charged directly to cost of sales. Any remaining inventory is backtracked and charged back to work in process and finished goods inventory accounts with a credit to cost of goods sold. If standard costing is used, variances are often closed to cost of goods sold because the inventory levels are minimal. K. Appendix C explains sales variances. Sales variances may be analyzed in terms of selling price or contribution margin. Sales variances are in terms of price variance (difference between actual and budgeted prices times actual quantity sold) and sales budget variance (difference between actual and budget volume times selling price). Sales volume variance can be further broken down into sales mix and sales quantity variances if there are two or more products involved. Sales mix determines whether a different mix from budget was sold whereas sales yield determines whether given the variation in mix, a different volume of products were sold. Sales quantity variance can be further broken down into sales market-size variance and sales market-share variance. Marketshare variance shows whether we sold more or less than the budgeted market share. Market size variance shows whether the budgeted market size differed from the actual market size. Problem 1 – Chapter 17 Learning objectives 8, 9, and 11 Analyzing sales and cost variances in an activity-based costing environment Time needed: 1 ½ hours Ryan International sells two products ; X and Y. The forecast calls for production of 1500 units of X and 2500 units of Y. Cost in addition to materials of $12 a unit for each product includes one hour of labor for X and two hours of labor for Y at $8 an hour. Unit level overhead amounts to $26,000 with labor hours as cost driver. Batch level costs amount to $16,500. A total of 30 batches of X and 25 batches of Y were to be run. Product level costs amount to $97,500. X uses ten parts per unit and Y uses 20 parts per unit. The budgeted selling price is $54 for X and $74 for Y. Budgeted facility-level costs are allocated based on number of units produced and amount to $40,000. Actual production amounted to 1600 units of X and 2200 of Y. Material and labor costs remained at the budgeted level. Unit level costs amounted to $25,200. Batch level costs amounted to $17,400 with 26 batches for X and 20 batches for Y. Product level costs amounted to $93,000 with 12 parts per unit for X and 19 parts per unit for Y. The actual selling prices were $52 for X and $78 for Y. Actual facility-level costs amount to $43,800. Required: 1) Determine the budgeted and actual unit level cost per labor hour. 2) Determine the budgeted and actual batch level costs per unit of the cost driver. 3) Determine the budgeted and actual product level costs per unit of the cost driver. 4) Determine budgeted cost per unit of X and Y. 5) Determine variable overhead spending and efficiency variances. 6) Determine fixed overhead budget and volume variances. 7) Determine sales price and sales volume variances. 8) Determine sales mix and sales quantity variances. 9) Explain why facility-level costs are often not allocated and why variable overhead spending variance is not as meaningful as other variances. Solution: 1, 2, 3, Budget $ C/driver Cost/unit Actual $ C/driver Cost/unit Unit-level costs 26,000 6,500 4 25,300 6000 4.22 Batch-level costs 16,500 55 300 17,400 46 378.26 Product-level costs 97,500 65,000 1.5 93,000 61000 1.52 4) Budget; Actual X Y X Y Direct material 12 12 12.00 12.00 Direct labor 8 16 8.00 16.00 Unit-level overhead 4 8 4.22 8.43 Batch-level overhead 6 4 6.15 3.44 Product-level costs 15 30 18.30 28.97 Cost per unit 45 70 48.66 68.84 5) Variable overhead spending and efficiency variances: VOSV – unit-level: 25,200 – [(1600 * 1 * 4) + (2200 * 2 * 4)] = $1,200 U VOSV – batch-level: 17,400 – [(26 * 300) + (20 * 300)] = $3,600 U VOSV – product-level: 93,000 – (61,000 * 1.50) = $1,500 U VOEV – unit-level: (6000 – 6000) * 4 = 0 VOEV – batch-level: (46 - 54) * 300 = $2,400 F VOEV – product-level: (61,000 – [(1600 * 10) + (2200 * 20)] * 1.50 = $1,500 U 6) Fixed overhead budget and volume variances: FOBV 43,800 – 40,000 = $3,800 U FOH rate per unit : 40,000 / (1500 + 2500) = $10 7) Sales price and sales volume variances: SPV: [(52 – 54) * 1600] + [(78 – 74) * 2200] = $5,600 F SVV: [(1600 – 1500) * 54] + [(2200 –2500) * 74] = $16,800 U 8) Sales mix and sales quantity variances : SMV : [54 * (42.11% - 37.50%) * 3,800] + [74 * (57.89% - 62.50%) * 3,800] = $3,500 U (rounded) SQV : [54 * (3800 – 4000) * .375] + [74 * (3800 – 4000) * .625] = $13,300 U Note that the total of SMV + SQV = SVV: 3,500 U + 13,300 U = $16,800 U 9) Facility-level overhead are often not allocated to the individual products because there is not often a clear relationship between the facility-level cost incurred and the individual products. It is in the form of a sticky common cost. Variable overhead spending variance is difficult to interpret because the cost drivers used may not be clearly in line with the amounts spent. This variance should be viewed with caution to avoid misinterpretation. Problem 2: Overhead (Comprehensive) – Solution provided. Budgeted direct labor 3 hours @ $10 an hour for 1000 units; Variable overhead is estimated to be $6 per direct labor hour; Budgeted fixed overhead amounts to $42,000 Actual output amounted to 1200 units using 3,720 labor hours. Actual variable overhead amounted to $21,576. Actual fixed overhead amounted to $48,600. Required: 1) Compute the predetermined overhead rate. 6 + [42,000 / (1,000 * 3)] = $20 per direct labor hour 2) Compute the amount of overhead applied. 1,200 * 3 * 20 = $72,000 3) Compute the amount of over/underapplied overhead. 70,176 – 72,000 = $1,824 overapplied 4) Compute total variable overhead variance. 21,576 – (1200 * 3 * 6) = $24F 5) Compute variable overhead spending variance. 21,576 – (3,720 * 6) = $744 F 6) Compute variable overhead efficiency variance. (3,720 – 3,600) * 6 = $720 U 7) Compute total fixed overhead variance. 48,600 – (1,200 * 3 * 14) = $1,800 F 8) Compute fixed overhead budget variance. 48,600 – 42,000 = $6,600 U 9) Compute fixed overhead volume variance. 42,000 – (1,200 * 3 * 14) = $8,400 F 10) Reconcile the variances to the amount of over/underapplied overhead: 744F + 720U + 6,600U + 8,400F = $1,824 Problem 3 LO: 2 and 3 Flexible budget and overhead applied Estimated time: 20 minutes Iraj Services actual and budgeted information on labor and overhead accounts follow. The actual volume was 12,100 units whereas the budget was based on 11,000 units. Overhead is based on machine time. Item Actual Budget Hours per unit 2.50 2.75 Variable overhead 332,750 317,625 Fixed overhead 322,750 330,000 Prepare a flexible budget report with columns for actual, budget, and variances. Also determine the amount of overhead applied. Item Actual Budget Flexible B. Variance Output 12,100.00 11,000.00 12,100.00 Hours per unit 2.50 2.75 2.75 Rate per hour 11.00 10.50 10.50 Total variable overhead 332,750.00 317,625.00 349,387.50 (16,637.50) Total fixed overhead 322,750.00 330,000.00 330,000.00 (7,250.00) Total overhead 655,500.00 647,625.00 679,387.50 (23,887.50) Fixed overhead rate per hour 10.6694 10.9091 Fixed overhead applied : 12,100 * 2.75 * 10.9091 = 363,000 (rounded) Variable overhead applied : 12,100*2.75*10.50 – 349,387.50 Overapplied overhead : (655,000 – (363,000 + 349,387.50)) = $57.387.50 Problem 4 LO: 5 and 6 Overhead variances Estimated time: 40 minutes : Iraj Services actual and budgeted information on labor and overhead accounts follow. The actual volume was 12,100 units whereas the budget was based on 11,000 units. Overhead is based on machine time. Item Actual Budget Hours per unit 2.50 2.75 Variable overhead 332,750 317,625 Fixed overhead 408375 423,500 Determine variable overhead spending and efficiency variance as well as fixed overhead budget and volume variance. Then, compute and explain three-way, and two-way variance analysis. Solution: Item Actual Standard Variance Output 12,100.00 12,100.00 Time 2.50 2.75 Variable overhead rate 11.00 10.50 Fixed overhead rate 13.50 14.00 Variable overhead 332,750.00 349,387.50 Fixed overhead 408,375.00 465,850.00 Total overhead 741,125.00 815,237.50 VOEV 317,625.00 349,387.50 VOSV 332,750.00 317,625.00 FOBV 408,375.00 423,500.00 FOVV 423,500.00 465,850.00 Total overhead variances (4-way analysis) VOEV 317,625.00 349,387.50 VOSV+FOBV 741,125.00 741,125.00 FOVV 423,500.00 465,850.00 Total overhead variances (3-way analysis) VOEV+VOSV+FOBV 741,125.00 772,887.50 FOVV 423,500.00 465,850.00 Total overhead variances (2-way analysis) (16,637.50) (57,475.00) (74,112.50) (31,762.50) 15,125.00 (15,125.00) (42,350.00) (74,112.50) (31,762.50) - (42,350.00) (74,112.50) (31,762.50) (42,350.00) (74,112.50) Note that one way analysis is simply the difference between actual and applied overhead which amounts to a favorable balance of $74,112.50. To analyze this further, we break it down into actual overhead versus flexible budget amount which gives us the flexible budget variance and the fixed overhead volume variance (2-way analysis). The next step is to see how much of the variance is due to efficiency (actual usage times the standard time) minus total standard variable overhead which is same as the allowed amount in the flexible budget. Then, we figure the spending variance (regardless of fixed or variable components) followed with fixed overhead volume variance (3-way analysis). The four-way analysis breaks down the variance into variable overhead efficiency variance, variable overhead spending variance, fixed overhead spending or budget variance, and fixed overhead volume variance as illustrated above. Problem 5 LO: 7 Journal entries related to overhead accounts in a standard costing system Estimated time: 20 minutes Iraj Services actual and budgeted information on labor and overhead accounts follow. The actual volume was 12,100 units whereas the budget was based on 11,000 units. Overhead is based on machine time. Item Actual Budget Hours per unit 2.50 2.75 Variable overhead 332,750 317,625 Fixed overhead 408375 423,500 Using a 4-way variance analysis, prepare all the necessary journals for the development and disposition of variances. Assume that the overhead balance of WIP, FG, and CGS accounts amount to $190,000, $310,000, and $500,000 respectively. Solution: Item DR CR Manufacturing overhead $741,125 Various accounts $741,125 Work in process 815,237.50 Manufacturing overhead applied 815,237.50 Manufacturing overhead applied 815,237.50 VOSV 15,125.00 VOEV 31,762.50 FOBV 15,125.00 FOVV 42,350.00 Manufacturing overhead 741,125.00 VOEV 31,762.50 FOBV 15,125.00 FOVV 42,350.00 VOSV 15,125.00 Work in process – 19% 14,081.38 Finished goods inventory – 31% 22,974.87 Cost of goods sold - 50% 37,056.25 Closing of all temporary accounts Sample Quiz 1. In a multi-product company, flexible budgets usually are based on a. actual input, such as direct labor hours. b. standard allowed input. c. actual output. d. Either of the above. e. None of the above. Answer: b Learning Objective: 1 2. In standard costing, overhead is applied to production based on a. actual number of cost driver input used times predetermined overhead rate. b. actual number of cost driver input used times actual overhead rate. c. standard allowed hours of cost driver input times actual overhead rate. d. standard allowed hours of cost driver input times predetermined overhead rate. e. None of the above. Answer: d Learning Objective: 2 3. In a three-way variance analysis a. fixed spending and variable spending and efficiency variances are combined into one. b. fixed and variable spending variances are combined into one. c. fixed spending and volume variances are combined into one. d. variable efficiency and fixed volume variances are combined into one. e. None of the above. Answer: b Learning Objective: 5 Use this data to respond to questions 4 to 7: Arman & Company makes two models of wheel chairs. Product A requires material per unit of $115 and direct labor per unit of $44. Product B requires material of $197 and labor of $86 per unit. Each unit of A requires 3 machine hours while B requires 4 machine hours. The forecasted output for the year is 1,200 units of A and 1,800 units of B. Labor related variable overhead amounts to $83,040 while machine related overhead amounts to $248,400. Fixed overhead of $140,040 is computed as a percentage of prime costs. 4. Labor-related variable overhead rate amounts to a. 30% b. 35% c. 40% d. 45% e. None of the above. Answer: c Learning Objective: 2 5. Fixed overhead rate amounts to a. 15% b. 20% c. 25% d. 30% e. None of the above. Answer: b Learning Objective: 2 6. Total budget for product A amounts to a. $322,880 b. $332,880 c. $828,800 d. $838,800 e. None of the above. Answer: b Learning Objective: 2 7. Cost per unit of product B (rounded) amounts to a. 277 b. 287 c. 466 d. 476 e. None of the above. Answer: c Learning Objective: 2 Use this data to respond to questions 8 through 10. Susan Cabinet shop has total budgeted variable overhead of $220,000. Actual variable overhead for the period also amounted to $220,000. The overhead is based on direct labor hours. Other data on the two types of cabinets are as follows: M N Budgeted hours per unit 12 16 Budgeted production 100 200 units Actual hours per unit 13 18 Actual number of units 140 160 8. The variable overhead applied amounts to a. $187,000 b. $216,000 c. $220,000 d. $224,000 e. None of the above. Answer: a Learning Objective: 4 9. Variable overhead per unit of M amounts to a. $600 b. $700 c. $800 d. $900 e. $950 f. None of the above. Answer: a Learning Objective: 4 10. Variable overhead spending variance amounts to a. –$15,000 b. $15,000 c. $23,000 d. – $23,000 e. None of the above. Answer: b Learning Objective: 5 Use this data to respond to questions 11 and 12. Omid Pen Company produces regular and deluxe pens. Budgeted fixed overhead amounts to $41,440. Actual fixed overhead amounts to $52,500. Other data follows: Item Regular Deluxe Budgeted machine hours per unit .20 .30 Budgeted number of units 3,800 2,400 Actual number of units produced 3,900 2,900 11. Fixed overhead applied amounts to a. $43,200 b. $44,200 c. $45,200 d. $46,200 e. None of the above. Answer: d Learning Objective: 5 12. Fixed overhead spending variance amounts to a. $4,760 b. –$4,760 c. –$6,300 d. –$11,060 e. $11,060 Answer: d Learning Objective: 5 13. Variable overhead spending variance amounts to 22,000 favorable and variable overhead efficiency variance amounts to 32,000 unfavorable. WIP inventory amounts to $50,000, Finished goods inventory $150,000, and cost of goods sold amounts to $200,000. The overhead portion of these accounts amounts to 20%, 40%, and 45% of same respectively. Closing and prorating the efficiency variance would a. increase work in process by $2,000. b. increase finished goods inventory by $12,000. c. increase cost of goods sold by $18,000. d. All of the above. e. None of the above. Answer: e Learning Objective: 9 14. If actual and budgeted production are equal but actual fixed costs are higher than budgeted fixed costs, fixed overhead volume variance would be a. positive. b. negative. c. zero. d. Can’t be determined. e. None of the above. Answer: c Learning Objective: 5 15. An unfavorable fixed overhead volume variance is indicative of a. lower than expected efficiency. b. lower output. c. higher costs of operation. d. All of the above. e. a and b Answer: b Learning Objective: 5 16. Which of the following variances would be least controllable by a production manager? a. overhead volume b. overhead efficiency c. labor efficiency d. material usage e. overhead spending Answer: a Learning Objective: 6 17. ABC Company has a JIT system and seldom keeps any inventory. However, at the end of this month, items left in WIP amount to $12,000 and finished goods balance amount to $23,500. The entry required in a traditional costing system would be a. Dr. WIP for 12,000, FG for 23,500, and credit cost of goods sold for $33,500. b. Dr. CGS for 33,500 and credit WIP for 12000, FG for $23,500. c. Dr. FG for 23,500 and credit CGS for $23,500 only. d. Dr. FG for 23,500 and credit WIP for $23,500. e. None of the above. Answer: d Learning Objective: 10 Use this data to respond to questions 18 through 20. Omid Printing has decided to break up its overhead into unit level costs of $45,000 with the primary cost driver being labor hours of 9000 hours; batch level costs of $15,000 with the cost driver being the number of batches which are estimated to be 300; and product level costs of $21,000 related to number of parts handled amounting to 10,500. Job one uses 95 labor hours, 3 batches, and 345 parts. Job two uses 125 labor hours, 7 batches, and 256 parts. The job allocations tie to the budget except that job one was supposed to use 125 labor hours and job two 95 hours. Also job one was supposed to use 4 batches and job two six batches. 18. The standard cost of job two amounts to a. $1,287 b. $1,315 c. $1,582 d. $1,610 e. None of the above. Answer: a Learning Objective: 8 19. Actual charge to job one (actual units at standard rates) amounts to a. $1,287 b. $1,515 c. $1,582 d. $1,610 e. None of the above. Answer: b Learning Objective: 8 20. What other data is needed for computing overhead spending variances? a. actual level of cost driver used for each activity b. actual costs related to each activity c. actual volume of output d. a and c e. a and b Answer: b Learning Objective: 8 Instructor Manual for Cost Management: Strategies for Business Decisions Ronald W. Hilton, Michael W. Maher, Frank H. Selto 9780073526805, 9780072430332, 9780072830088, 9780072299021, 9780072881820, 9780072882551, 9780070874664, 9780072388404, 9780072343533
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