Managerial Accounting: An Introduction To Concepts, Methods, And Uses Chapter 12 Cost Center Performance Evaluation Maher, Stickney and Weil

Learning Objectives (Slide 1 of 3) Explain how variable production cost variances are calculated and why they occur. Explain how fixed production cost variances are calculated and why they occur. Explain the difference between price and efficiency variances. Explain how to analyze variances using the variable cost variance model.

Learning Objectives (Slide 2 of 3) Analyze overhead variances using the variable cost variance model. Identify the relation between actual, budgeted, and applied fixed manufacturing costs. Explain how to apply activity-based costing to variance analysis.

Learning Objectives (Slide 3 of 3) Describe the impact of technology on variance analyses. Identify tools managers use to decide when to investigate variances. Explain how to calculate the mix variance portion of the efficiency variance.

Responsibility For Production Variances (Slide 1 of 2) Purchasing Department The materials price variance, used to evaluate the purchasing dept.'s performance, is calculated as follows: (Actual price - Standard Price) X Quantity Purchased Measures the difference between actual and standard prices paid for materials

Responsibility For Production Variances (Slide 2 of 2) The production dept. is responsible for the following variances: Fixed manufacturing cost variance Remaining variable manufacturing cost variance not assigned to purchasing including: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead

Reasons for Variances Variances occur for a variety of reasons: A variance is simply the difference between a predetermined norm (an expected amount) and actual results so some differences should be expected The standards may be biased Systematic reasons

Reasons for Materials Variances Generally, materials variances are attributable to two areas: Usage of materials Price paid for materials Examples: Accounting may fail to take purchase discounts on materials Employees may be poorly trained leading to higher waste

Reasons for Labor Variances Generally, labor variances are attributable to two areas: Usage of labor hours Price (or wage) paid for labor Examples: New employee is hired for less than expected wage rate Union contract may call for wage rate higher than forecast amount

Reasons for Variable Manufacturing Overhead Variances Generally, variable manufacturing overhead variances are attributable to two areas: Usage of allocation base (e.g., machine hours) Price of overhead items Example: Utility company lowers rates for electricity resulting in a favorable variance

Fixed Manufacturing Cost Variances Difference between actual and budgeted fixed costs Fixed costs do not vary with the level of activity Managers simply investigate what caused the difference Example: Rent on production facility was unexpectedly raised causing an unfavorable variance

Variable Overhead in Service Organizations Variable overhead is often significant for service firms, governmental agencies and nonprofit groups These types of organizations set standards, perform variance analysis and establish flexible budgets

Separating Variances into Price & Efficiency Components Variable manufacturing cost variances can be spit into two components Price variance - the difference between the budgeted (or standard) price and the actual price paid Efficiency variance - measures the difference between the actual quantity of inputs used and those allowed at standard to make a unit of output

Variable Cost Variance Model (Slide 1 of 2) Flexible Production Budget (SP X SQ) (3) Actual (AP X AQ) (1) Inputs at Standard (SP X AQ) (2) Price Variance (1) - (2) (AP - SP) X AQ Efficiency Variance (2) - (3) SP X (AQ - SQ) Total Variance (1) - (3)

Variable Cost Variance Model (Slide 2 of 2) General model can be used to calculate the following variances: Input Price Variance Efficiency Variance Direct Materials Price Variance Quantity Variance Direct Labor Rate Variance Efficiency Variance Variable Ovrhd Spending Variance Efficiency Variance

Reasons for Materials Price & Efficiency Variances Materials price variances may result from: Failure to take purchase discounts Purchasing higher or lower quality material Materials efficiency variances may result from: Purchasing inferior materials Using materials more or less efficiently

Reasons for Labor Price & Efficiency Variances Labor price variances may result from: Failure to correctly anticipate changes in wage rates Hiring new employees at wage rates different from standard Labor efficiency variances may result from: Workers being poorly trained Faulty equipment Scheduling problems

Variable Overhead Price and Efficiency Variances Price and efficiency variances for variable overhead are computed using the same method as for other variable manufacturing costs Requires a measure of overhead input activity such as machine hours or direct labor hours Care should be taken in interpreting these variances since the input activity base may be chosen without regard for the true cause of variable overhead costs

Fixed Manufacturing Cost Variances (Slide 1 of 3) Manufacturing companies, using full absorption costing, use a predetermined overhead rate to apply fixed overhead to units produced, calculated as follows: Estimated Fixed Manufacturing Cost per Period Estimated Production Volume per Period This rate is applied to units produced during the period

Fixed Manufacturing Cost Variances (Slide 2 of 3) The production volume variance equals budgeted fixed manufacturing costs minus applied fixed manufacturing costs Only arises when fixed costs are allocated to units using a predetermined rate and estimated production volume is different from actual production volume achieved The production volume variance appears to have little benefit for managerial purposes

Fixed Manufacturing Cost Variances (Slide 3 of 3) The price (spending) variance for fixed manufacturing costs equals the difference between actual and budgeted costs Used for management and control of fixed manufacturing costs

Quality Control and Variance Investigation Managers use a variety of methods to determine which variances should be investigated, including: Rules of thumb such as investigate variances > 10% of standard cost Tolerance limits - use predetermined limits within which variances may fluctuate Variances outside these limits are investigated Decisions models

Dr. Donald R. Trippeer, CPA Colorado State University-Pueblo If you have any comments or suggestions concerning this PowerPoint Presentation for Managerial Accounting, An Introduction To Concepts, Methods, And Uses, please contact: Dr. Donald R. Trippeer, CPA donald.trippeer@colostate-pueblo.edu Colorado State University-Pueblo