1. Fundamental Managerial Accounting Concepts Thomas P. Edmonds Bor-Yi Tsay Philip R. Olds Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Fifth Edition

2. ©The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin Chapter Eight Performance Evaluation

3. F = Favorable variance Actual sales exceeded budgeted level of sales. Preparing Flexible Budgets

5. Would you expect these variances to be favorable or unfavorable given the favorable sales variance? Preparing Flexible Budgets

6. The relevant question is... “What portion of the variances is due to activity and price changes, and what portion is due to cost control?” To answer the question, we must the budget for the actual activity.

7. Preparing Flexible Budgets Melrose Manufacturing, a producer of small high-quality trophies, plans to make and sell 18,000 trophies during 2006. Melrose uses a standard cost system as outlined below:

8. Preparing Flexible Budgets From the standard cost information, Melrose prepares the following static and flexible budgets. 18,000 × $80 = $1,440,000

9. Central Concept If you can tell me what your activity was for the period, I will tell you what your costs and revenue should have been. Preparing Flexible Budgets

10. Determining Variances for Performance Evaluation The differences between standard and actual amounts are called variances. A variance may be favorable or unfavorable. When actual sales are less than expected sales, an unfavorable sales variance exists. When actual costs are more than standard costs, an unfavorable cost variance exists. and visa versa

11. Sales Volume Variances The difference between the static budget sales amount and the flexible budget sales amount is a measure of the sales volume variance.

12. Interpreting the Volume Variances In the case of Melrose, the marketing manager (who is usually responsible for the volume variance) exceeded planned sales volume by 1,000 units, resulting in an $80,000 favorable revenue variance ($80 × 1,000). The unfavorable cost variances are somewhat misleading. Melrose incurred higher costs because it manufactured and sold more units than planned.

13. Interpreting the Volume Variances Because actual volume is not known until the end of the period, the selling price must be based on planned volume. At the planned volume of 18,000 units, Melrose’s fixed cost per unit is expected to be as follows: Based on actual volume, fixed cost per unit would be $15.35 ($291,600 ÷ 19,000).

14. Flexible Budget Variances Now we are comparing actual results achieved with the results that should have been achieved at that actual activity level. $78 × 19,000 = $1,482,000

15. Calculating Sales Price Varianceor

16. Establishing Standards A standard represents the amount a price, cost, or quantity should be, based on certain anticipated circumstances. Accountants, engineers, purchasing agents, and production managers combine efforts to set standards that encourage efficient future production.

17. Establishing Standards ideal standards Should we use ideal standards that represents what costs should be under the best circumstances? Engineer Managerial Accountant practical standards I recommend using practical standards that an average worker performing diligently would be able to achieve.

18. Establishing Standards Lax standards create motivational problems. Production Manager Human Resource Manager I agree. Ideal standards based on perfection, are unattainable and discourage most employees

19. Need for Standard Costs Management by exception Standard costs help managers plan and establish benchmarks against which actual performance can be judged. Management by exception focuses on material differences between actual and expected results.

20. Selecting Variances to Investigate Management by exception tells us to consider: 1.the materiality of a variance, 2.how frequently it occurs, 3.the capacity to control the variance, and 4.the characteristics of the items behind the variance. Management by exception tells us to consider: 1.the materiality of a variance, 2.how frequently it occurs, 3.the capacity to control the variance, and 4.the characteristics of the items behind the variance.

21. Flexible Budget Variances Recall: we are comparing actual results achieved with the results that should have been achieved at the activity level.

22. Price and Usage Variances Price Variance Standard Cost Variances The difference between the actual price and the standard price Usage Variance The difference between the actual quantity and the standard quantity

23. Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price VarianceUsage Variance Standard price is the amount that should have been paid for the resources acquired. Price and Usage Variances

24. Price VarianceUsage Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Standard quantity is the quantity that should have been used for the output achieved. Price and Usage Variances

25. AQ AP - SP SP AQ - SQ AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity AQ AP - SP SP AQ - SQ AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Price VarianceUsage Variance Price and Usage Variances

26. Hanson Inc. has the following material standards to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound Last week 1,700 pounds of material were purchased and used to make 1,000 Zippies. The material cost a total of $6,630. Calculating the Materials Price and Usage Variances Zippy

27. Price variance $170 favorable Usage variance $800 unfavorable 1,700 lbs. 1,700 lbs. 1,500 lbs. × × × $3.90 per lb. $4.00 per lb. $4.00 per lb. = $6,630 = $ 6,800 = $6,000 Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Material Variances Summary Zippy $630 Unfavorable Total Variance $630 Unfavorable

28. Materials Price VarianceMaterials Quantity Variance Production ManagerPurchasing Manager The standard price is used to compute the quantity variance so that the production manager is not held responsible for the purchasing manager’s performance. Responsibility for Materials Variances

29. I am not responsible for this unfavorable material quantity variance. You purchased inferior material, so my people had to use more of it. You purchased inferior material, so my people had to use more of it. Production Manager Your poor scheduling sometimes requires me to rush order material at a higher price, causing unfavorable price variances. Purchasing Manager

30. Flexible Budget Variances Recall: we are comparing actual results achieved with the results that should have been achieved at the activity level.

31. AH AP – SP SP AH – SH AH = Actual Hours SP = Standard Price AP = Actual Price SH = Standard Hours AH AP – SP SP AH – SH AH = Actual Hours SP = Standard Price AP = Actual Price SH = Standard Hours Actual Hours Actual Hours Standard Hours × × × Actual Price Standard Price Standard Price Price VarianceUsage Variance Labor Price and Usage Variances

32. Hanson Inc. has the following direct labor standard to manufacture one Zippy: 1.5 standard hours per Zippy at $6.00 per direct labor hour Last week 1,550 direct labor hours were worked at a total labor cost of $9,610 to make 1,000 Zippies. Labor Variances Zippy

33. Calculating Labor Variances Hanson has provided the following information about labor cost and usage during the period.

34. Labor Price variance $310 unfavorable Labor Usage variance $300 unfavorable 1,550 hours 1,550 hours × × $6.20 per hour $6.00 per hour = $9,610 = $9,300 Actual Hours Used Actual Hours Used Standard Hours × × × Actual Price per Hr Standard Price Per Hr Standard Price Per Hr Hanson Labor Variances Summary Actual Cost Column Standard Cost Column Variance Dividing Column $610 Unfavorable Total Variance $610 Unfavorable 1,500 hours x $6.00 per lb. = $9,000

35. Calculating Labor Variances Melrose has provided the following information about labor cost and usage during the period.

36. Labor Price variance $14,250 favorable Labor Usage variance $22,800 unfavorable 28,500 hours 28,500 hours × × $11.50 per hour $12.00 per hour = $327,750 = $342,000 Actual Hours Used Actual Hours Used Standard Hours × × × Actual Price per Hr Standard Price Per Hr Standard Price Per Hr Labor Variances Summary Actual Cost Column Standard Cost Column Variance Dividing Column $8,550 Unfavorable Total Variance $8,550 Unfavorable 26,600 hours x $12.00 per lb. = $319,200

37. Flexible Budget Variances Now we are comparing actual results achieved with the results that should have been achieved at the activity level.

38. Labor Price and Usage Variances Price Variance = Actual Hours × Actual Price Standard Price – = $14,250 Favorable = × –($11.50 $12.00)28,500 Usage Variance = Standard Price × Actual Hours Standard Hours – = $22,800 Unfavorable = × –(28,500 26,600)$12.00

39. Responsibility for Labor Variances Production Manager Production managers are usually held accountable for labor variances because they can influence the: Mix of skill levels assigned to work tasks. Level of employee motivation. Quality of production supervision. Quality of training provided to employees.

40. Responsibility for Labor Variances I am not responsible for the unfavorable labor efficiency variance! You purchased cheap material, so it took more time to process. You purchased cheap material, so it took more time to process. I think it took more time to process the materials because the Maintenance Department has poorly maintained your equipment. Production Manager Purchasing Manager

41. Fixed Overhead Variances Variable costs can have both price and usage variances. Fixed overhead costs can have a price variance. The difference between the actual fixed overhead costs paid and the budgeted fixed overhead costs is called the spending variance. At Melrose, the spending variance was: ($201,600 budgeted – $210,000 actual) = $8,400 Unfavorable

42. Fixed Overhead Variances Volume Overhead Volume Variance ($201,600 budgeted – $212,800 applied) = $11,200 Favorable Allocated to production

43. Fixed Overhead Variances Actual Fixed Cost Budgeted Fixed Cost $210,000 $201,600 Unfavorable Spending Variance $8,400 Unfavorable Applied Fixed Cost $212,800 Favorable Volume Variance $11,200 Favorable

44. End of Chapter Eight