1. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Chapter 23 1

2. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 2 Prepare a flexible budget for the income statement Prepare an income statement performance report Identify the benefits of standard costs and learn how to set standards Compute standard cost variances for direct materials and direct labor

3. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 3 Analyze manufacturing overhead in a standard cost system Record transactions at standard cost and prepare a standard cost income statement

4. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Budget variance—the difference between an actual amount and a budgeted figure Managers use variances to operate a business Important to know why actual amounts differ from the budget Enables managers to identify problems and decide upon actions to take 4

5. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Prepare a flexible budget & performance report for the income statement 1 1 5 2 2

6. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Let’s look at CheeseCo. Static budgets are prepared for a single, planned level of activity. Performance evaluation is tricky when actual activity differs significantly from the planned level of activity. Hmm… Comparing static budgets with actual costs is like comparing apples and oranges.

7. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. CheeseCo

8. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. CheeseCo

9. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. CheeseCo How much of the $11,650 is due to activity and how much is due to cost control?

10. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. CheeseCo How well did we control costs? What should our variable costs be at our actual volume? Yes, they should change because of volume. How much they should change is easily answered by the flexible budget.

11. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The relevant question is... “How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?” To answer the question, we the budget to the actual level of activity. The relevant question is... “How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?” To answer the question, we the budget to the actual level of activity.

12. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Prepare for any activity level in the relevant range. Show revenues and expenses that should have occurred at the actual level of activity. Isolate management driven variances from volume driven ones.

13. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. To a budget we need to remember: Total variable costs change in direct proportion to changes in activity. Total fixed costs remain unchanged within the relevant range. Fixed Variable

14. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Let’s prepare budgets for CheeseCo.

15. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. CheeseCo CostTotal Flexible Budgets FormulaFixed8,00010,00012,000 Per HourCostHours Machine hours8,000 10,000 12,000 Variable costs Indirect labor4.00 $ 40,000$ Indirect material3.00 30,000 Power0.50 5,000 Total variable cost7.50$ $ 75,000$ Fixed costs Depreciation12,000$ $ $ Insurance 2,000 Total fixed cost14,000$ $ Total overhead costs$ 89,000$ 12,000 2,000 14,000 2,000 ÷ 3 21

16. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. CheeseCo CostTotal Flexible Budgets FormulaFixed8,00010,00012,000 Per HourCostHours Machine hours8,000 10,000 12,000 Variable costs Indirect labor4.00 48,000$ 40,000$ Indirect material3.00 36,000 30,000 Power0.50 6,000 5,000 Total variable cost7.50$ 90,000$ 75,000$ Fixed costs Depreciation 12,000 $ $ $ Insurance 2,000 Total fixed cost14,000$ $ Total overhead costs104,000$ 89,000$ $4.00 per hour × 12,000 hours = $48,000 12,000$ 2,000 14,000$ 2,000

17. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. CheeseCo CostTotal Flexible Budgets FormulaFixed8,00010,00012,000 Per HourCostHours Machine hours8,000 10,000 12,000 Variable costs Indirect labor4.00 48,000$ 40,000$ Indirect material3.00 36,000 30,000 Power0.50 6,000 5,000 Total variable cost7.50$ 90,000$ 75,000$ Fixed costs Depreciation12,000$ $ $ Insurance2,000 Total fixed cost14,000$ $ Total overhead costs104,000$ 89,000$ Can you figure out the total overhead costs at 8,000 hours?

18. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. CostTotal Flexible Budgets FormulaFixed8,00010,00012,000 Per HourCostHours Machine hours8,000 10,000 12,000 Variable costs Indirect labor4.00 32,000$ 40,000$ 48,000$ Indirect material3.00 24,000 30,000 36,000 Power0.50 4,000 5,000 6,000 Total variable cost7.50$ 60,000$ 75,000$ 90,000$ Fixed costs Depreciation12,000$ $ $ $ Insurance2,000 Total fixed cost14,000$ $ $ Total overhead costs74,000$ 89,000$ 104,000$ CheeseCo

19. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. How much of the $11,650 is due to activity and how much is due to cost control?

20. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Let’s prepare a budget performance report for CheeseCo.

21. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. CostTotal FormulaFixedFlexibleActual Per HourCostsBudgetResultsVariances Machine hours8,000 0 Variable costs Indirect labor4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material3.00 24,000 25,500 Power0.50 4,000 3,800 Total variable costs7.50$ 60,000$ 63,300$ Fixed Expenses Depreciation12,000$ $ $ Insurance2,000 2,050 Total fixed costs14,000$ 14,050$ Total overhead costs74,000$ 77,350$ CheeseCo ?

22. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. CostTotal FormulaFixedFlexibleActual Per HourCostsBudgetResultsVariances Machine hours8,000 0 Variable costs Indirect labor4.00$ 32,000$ 34,000$ $ 2,000 U Indirect material3.00 24,000 25,500 1,500 U Power0.50 4,000 3,800 Total variable costs7.50$ 60,000$ 63,300$ Fixed Expenses Depreciation12,000$ $ $ Insurance2,000 2,050 Total fixed costs14,000$ 14,050$ Total overhead costs74,000$ 77,350$ CheeseCo ? ?

23. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. CheeseCo

24. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Identify the benefits of standard costs and learn how to set standards 3 3 24

25. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Example: Our standard cost for pretzel dough is $4 per pound. Our standard dough quantity per pretzel is ¼ pound. Standard cost for dough used in one pretzel is $1.00. An estimate of what the costs of production should be Based on history, competition, engineering, supplier research, etc. Use the total costs for each input

26. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Pretzel Dough Management by exception: Managers focus on quantities and costs that differ from standards.. Type of Product Cost Dollars Spent Direct Labor Manufacturing Overhead Standard

27. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 27 Budget for a single unit Each unit has standards for price and quantity Inputs: Direct materials Price – total unit cost of materials in each product Quantity – amount used to make each product Direct Labor Price – Total wage rate for employees involved in making the product Quantity – time used to make each product

28. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Helps managers: Prepare the master budget Set sales prices of products and services Establish performance benchmarks quantities allowed and costs per unit Management by exception Efficient to track standard costs through cost flow Initial set up costs offsetting 28

29. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 29

30. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Direct materials Base purchase cost of each unit of inventory Consider early-pay discounts, freight-in, receiving costs Managers look for ways to cut costs Accountants work with managers to set price standard Direct labor Consider pay rates, payroll taxes, and fringe benefits Accountants work with human resources for labor rates Manufacturing overhead Identify appropriate allocation base Accountants work with production managers Price Standards 30

31. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Direct materials Analyze every input in the production process Consider product specifications, spoilage, scheduling Direct labor Consider time requirements for production, experience and learning curve Use of time-and-motion studies and benchmarking Manufacturing overhead Appropriate allocation base chosen Accountants work with production managers 31

32. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Standard cost variance analysis helps us pinpoint the cause of the flexible budget variance 32

33. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Compare actual production costs to standard costs to explain the flexible budget variances Isolate variances into price caused and quantity caused Variance Relationships 33 How well material and labor prices are kept within standards How well a company uses its materials or human resources

34. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Measures how well the business keeps unit costs within standards Difference in price of an input, multiplied by the actual quantity used. 34

35. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Measures how well the business uses its materials or human resources It is the difference in quantities multiplied by the standard price per unit 35

36. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The Relationships Among Price, Efficiency, Flexible Budget, Sales Volume, and Static Budget Variances This table illustrates two points: First, the price and efficiency variances add up to the flexible budget variance Second, static budgets play no role in the price and efficiency variances The static budget is used to compute the sales volume variance 36

37. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Compute standard cost variances for direct materials and direct labor 4 4 37

38. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Determine cost standards for materials, labor, and overhead Direct materials price standard for vinyl: Purchase price, net of discounts $1.90 per square foot Delivery, receiving, and inspection 0.10 per square foot Total standard cost per square foot of vinyl $2.00 per square foot Direct labor (DL) price (or rate) standard: Hourly wage $ 8.00 per direct labor hour Payroll taxes and fringe benefits 2.50 per direct labor hour Total standard cost per direct labor hour $10.50 per direct labor hour Variable overhead price (or rate) standard Fixed overhead price (or rate) standard: 38 = = $2.00 per DL hour Estimated variable overhead cost $6,400 Estimated quantity of allocation base 3,200 DL hours = = $3.00 per DL hour Estimated fixed overhead cost $9,600 Estimated quantity of allocation base 3,200 DL hours

39. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. To compute variances, use the flexible budget and actual results Investigate the $2,800 direct materials variance 39

40. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Identify costs involved for Smart Touch Recall standard cost Materials - $2.00 per square foot of vinyl Labor - $10.50 per direct labor hour Overhead Variable overhead price (or rate) standard is $2.00 per direct labor hour Fixed overhead price (or rate) standard is $3.00 per direct labor hour Identify the cost of one unit of production Materials = 1 square foot per DVD = $2.00 Labor =.40 hours per DVD = $4.20 Variable Overhead =.40 hours per DVD = $0.80 Actual Sales Results = 10,000 40

41. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 41

42. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Two types of direct materials variances: Direct materials price variance Direct materials efficiency variance 42

43. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Johnson, Inc., is a manufacturer of lead crystal glasses. The standard materials quantity is 0.8 pound per glass at a price of $0.30 per pound. The actual results for the production of 6,900 glasses was 1.1 pounds per glass, at a price of $0.40 per pound. 1.Calculate the materials price variance and the materials efficiency variance. Materials Price Variance = (AP – SP) x AQ = ($0.30 per pound – $0.40 per pound) x 6,900 glasses x 1.1 lb = (– $0.10 per pound) x 7,590 pounds = – $759 unfavorable Direct Materials Efficiency Variance = (AQ – SQ) x SP = (7,590 – 5,520) x $0.30 per pound = (2,070) x $0.30 per pound = $621 unfavorable 43

44. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. To compute variances, use the cost computed for the flexible budget and actual results Follow the direct labor variance of $ 200 44

45. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 45

46. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Two types of direct labor variances: Direct labor price (rate) variance Direct labor efficiency variance 46

47. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Johnson, Inc., manufactures lead crystal glasses. The standard direct labor time is 0.3 hour per glass, at a price of $13 per hour. The actual results for the production of 6,900 glasses were 0.2 hour per glass, at a price of $10 per hour. 1.Calculate the labor price variance and the labor efficiency variance. Direct Labor Price Variance = (AP – SP) x AH = ($10.00 – $13.00) x 1,380 hours = ($3.00) x 1,380 hours = $4,140 favorable Direct Labor Efficiency Variance = (AH – SH) x SP = (1,380 hours – 2,070 hours) x $13.00 per hour = (690 hours) x $13.00 per hour = $8,970 favorable 47

48. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Analyze manufacturing overhead in a standard cost system 5 5 48

49. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Total overhead variance—the difference between actual overhead cost and standard overhead allocated to production Allocating Overhead in a Standard Cost System 49

50. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Refer to the data from Johnson, Inc., in S23-6 and S23-7. The following information relates to the company’s overhead costs: Static budget variable overhead $ 9,000 Static budget fixed overhead $ 4,500 Static budget direct labor hours 1,800 hours Static budget number of glasses 6,000 Johnson allocates manufacturing overhead to production based on standard direct labor hours. Last month, Johnson reported the following actual results: actual variable overhead, $10,200; actual fixed overhead, $2,830. 1.Compute the standard variable overhead rate and the standard fixed overhead rate. 50 Standard overhead rate = Budgeted overhead cost Budgeted direct labor hours Standard variable = $9,000 / 1,800 hours = $5 per DL hour Standard fixed = $4,500 / 1,800 hours = $2.50 per DL hour

51. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Variable overhead variance analysis should tell us if we spent more in overhead by using too many hours of the cost driver, or too many resources during each hour. 51

52. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 52

53. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Two types of variable overhead variances: Variable overhead spending (price) variance Variable overhead efficiency variance 53

54. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Refer to the Johnson data in S23-6, S23-7, and S23-9. Compute the variable overhead variance. Use Exhibits 23-11 and 23-12 as guides. VOH Spending Variance =(AP x AH) - (SP x AH) = 10,200 – (1,380 x $5) = $3,300 (U) VOH Efficiency Variance = (AH – SH) x SP = (1,380 – 2,070) x $5 = $3,450 (F) 54

55. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. To compute variances, use the cost computed for the flexible budget and actual results Follow the fixed overhead variance of $2,700 55

56. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Total overhead variance—the difference between actual overhead cost and standard overhead allocated to production Allocating Overhead in a Standard Cost System 56

57. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Two types of variable overhead variances Spending: We overspent on the set amount of fixed overhead resources we bought, hence the $2,700 unfavorable pricing variance Volume Variance: We over-applied FMOH based on our standard time allowed, indicating that we may have excess underutilized capacity. 57

58. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Refer to the Johnson data in S23-6, S23-7, and S23-9. Compute the fixed overhead variances. Use Exhibits 23-12 as a guide. FOH Spending Variance = Actual fixed overhead – Budgeted fixed overhead = $2,830 – (1,800 x $2.50) = $1,670 (F) FOH Volume Variance = Actual fixed overhead – Applied fixed overhead = (1,800 x $2.50) – (2,070 x $2.50) = $675 (F) 58

59. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Record transactions at standard cost and prepare a standard cost income statement 6 6 59

60. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Records variances from standards as soon as possible Records direct materials price variances when materials are purchased Work in process inventory is debited at standard input quantities and standard prices 60

61. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Manufacturing wages is debited at standard prices for direct labor hours actually used Work in process inventory is debited for the standard cost per direct labor hour that should have been used 61

62. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Record actual overhead cost for June Record the overhead allocated to Work in process inventory computed 62

63. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Record the transfer of the standard cost of the DVDs completed from Work in process inventory to Finished goods Record the transfer of the cost of sales of the 10,000 DVDs sold at standard cost 63

64. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Closes the Manufacturing overhead account and records the overhead variances 64

65. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 65

66. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 66

67. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The master budget is a static budget, which means it is prepared for only one level of sales volume. A variance is the difference between an actual amount and a budgeted amount. A flexible budget summarizes costs and revenues for several different volume levels within a relevant range. An income statement performance report is prepared at the end of the period to measure actual results against the flexible and static budgets. A static budget variance occurs because actual activity differed from what was expected in the static budget. 67

68. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The static budget variance is divided into two variances: The flexible budget variance arises because the company had different revenues and/or costs than expected for the actual level of units sold. The sales volume variance arises because the actual number of units sold differed from the number of units on which the static budget was based. Most companies use standard costs to develop their flexible budgets. Standard cost is a budget for a single unit of materials, labor, and overhead. Price variances measure the difference in actual and standard prices. Efficiency variances measure the difference in actual and standard quantities used. 68

69. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Standard cost variances for direct materials and direct labor are each split between the price variance and efficiency variance. The price variance measures the difference between actual and standard price for direct materials and labor used. The efficiency variance measures the difference between actual and standard usage for direct materials and labor based on standard prices. In analyzing each variance, management must consider the overall effect of each decision and how it affected overall results for the production period. 69

70. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. When companies utilize standard costs, journal entries are made using standard costs, and variances are recorded at the same time. The variances are then shown on a standard costing income statement to highlight variances to management for more efficient decision making. 70

71. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 71

72. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 72 Copyright All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.