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

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

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

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

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

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Static budget Prepared for one level of sales volume Does not change after developed Variances classification Favorable (F) if an actual amount increases operating income Unfavorable (U) if an actual amount decreases operating income Flexible budget Prepared for several different volume levels within a relevant range Separates fixed and variable costs Variable costs put the “flex” in the flexible budget 6

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Need to know: Selling price per unit Variable cost per unit Total fixed costs Different volume levels within the relevant range 7

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Consider the following definitions. Give the cost term to the correct definition—Flexible Budget, Flexible Budget Variance, Sales Volume Variance, Static Budget, and Variance 1.A summarized budget for several levels of volume that separates variable costs from fixed costs. 2. The budget prepared for only one level of sales volume. 3. The difference between an actual amount and the budget. 4. The difference arising because the company actually earned more or less revenue, or incurred more or less cost, than expected for the actual level of output. 5. The difference arising only because the number of units actually sold differs from the static budget units. 8 Flexible Budget Static Budget Variance Flexible Budget Variance Sales Volume Variance

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Prepare an income statement performance report 2 2 9

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Managers need to know why variance occurred To pinpoint problems To take corrective action Managers divide the static budget variance into two broad categories Flexible budget variance Occurs because sales price per unit, variable cost per unit, and/or fixed cost was different than planned Sales volume variance Arises because actual number of units sold differs from the amount in the static budget 10

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Computations 11

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 12

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Moje, Inc., manufactures travel locks. The budgeted selling price is $19 per lock, the variable cost is $8 per lock, and budgeted fixed costs are $15, Prepare a flexible budget for output levels of 4,000 locks and 7,000 locks for the month ended April 30, Moje, Inc. Flexible Budget Month Ended April 30, 2012 Flexible BudgetOutput Units (Locks) per Output Unit4,0007,000 Sales revenue$19 $76,000$133,000 Variable expenses$ 832,00056,000 Contribution margin 44,000 77,000 Fixed expenses 15,000 Operating income (loss)$ 29,000$62,000

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

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 15 Budget for a single unit Each unit has standards for price and quantity Inputs: Direct materials Price – per unit cost of materials in each product Quantity – amount used to make each product Direct Labor Price – wage rate for employees involved in making the product Quantity – time used to make each product

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 16

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 17

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: 18 = = $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

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 19

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Helps managers: Prepare the master budget Set target levels of performance (static budget) Identify performance standards (standard quantities and standard costs) Set sales prices of products and services Decrease accounting costs Requires upfront cost to develop standards: Save accounting costs in the future Avoids LIFO, FIFO and average cost computations 20

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Once established, use the standard cost to assign costs to production Once a year, compare actual production costs to standard costs to locate variances Variance Relationships 21 How well material and labor prices are kept within standards How well a company uses its materials or human resources

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. 22

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 23

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 24

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

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Main concern: The $4,000 unfavorable flexible budget variance 26

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Identify fixed and variable costs Recall standard cost (computed earlier) 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 27

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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 materials variance of $2,800 29

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Two types of direct materials variances: Direct materials price variance Direct materials efficiency variance 30

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 $

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Two types of direct labor variances: Direct labor price (rate) variance Direct labor efficiency variance 32

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 33

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 34

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

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 36

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 variable overhead variance of $1,000 37

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Two types of variable overhead variances: Variable overhead spending (price) variance Variable overhead efficiency variance 38

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 39

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Two types of variable overhead variances Fixed overhead spending variance Fixed overhead volume variance 40

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, Compute the standard variable overhead rate and the standard fixed overhead rate. 41 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

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 and fixed overhead variances. Use Exhibits and 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) 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) 42

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

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 44

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 45

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 46

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 47

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Closes the Manufacturing overhead account and records the overhead variances 48

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 49

Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 50

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. 51

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. 52

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. 53

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. 54

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Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 56 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.