chapter 10 accounting

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chapter 10 accounting

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The costvolumeprofit analysis discussed in Chapter 3 provided insights into how revenues,

costs, and profits respond to changes in the quantity of product made and sold. However, that

analysis assumed a constant product mix.

Spreadsheet softwares make it possible to consider product mixes (and much more) so that

managers can evaluate alternative strategies. Managers can explore the effects of alternative

marketing, production, and selling strategies. Such alternative proposals can be evaluated in a

what-if analysis

The structure and information required to prepare the master budget can be used easily to

provide the basis for what-if analysis.

Sensitivity Analysis

Sensitivity analysis is the process of selectively varying a plans or a budgets key estimates

for the purpose of identifying over what range a decision option is preferred.

Planners test planning models by varying the model estimates, to see how it affects the plan.

If small forecasting errors of an estimate used in the production plan change the plan, we say

that the model is sensitive to that estimate. If the performance consequences (for example,

profits) from a bad estimate are severe, planners may want to invest time and resources to

improve the accuracy of their estimates.

Both what-if and sensitivity analyses use the same model to evaluate future alternatives.

However, the approaches differ in their purposes. What-if-analysis is a process that uses a model

to predict the results of varying that models key parameters or estimates. Sensitivity analysis is

the process of selectively varying key estimates of a plan or a budget to identify over what range

a decision option is preferred. In this way, sensitivity analysis enables planners to identify

estimates critical to the decision under consideration. What-if-analysis relies on that model

tested via sensitivity analysis

Exercise 10-42

Jeren Company is considering replacing its existing cutting machine with a new

machine that will help reduce its defect rate.

Relevant information for the two machines includes the following:

Monthly fixed cost $32,000 $40,000

Variable cost per unit $44 $40

Sales price per unit $55 $55

(a) Determine the sales level, in number of units, at which the costs are the same for both

machines.

(b) Determine the sales level in dollars at which the use of the new machine results in a 10%

profit on sales (profit/sales) ratio.

a. Let Q sales level in units at which the costs are the same with both machines.

($44 Q) + $32,000 = ($40 Q) + $40,000

$4Q = 8,000

Q = 2,000 units

b. Let R sales level in dollars at which the use of the new machine results in a 10% profit on

sales ratio.

Q = $40,000 / [15 (.10 x 55)]

Q = $40,000/ 9.5 = 4,211 units

R= $55 x 4,211 = $231,605

Variance Analysis

Variance analysis comparison of planned (or budgeted) results with actual results

- What caused the variance

- What should be done to correct that variance

New slide

Budgeted or planned costs can come from three sources:

Standards established by industrial engineers

Previous periods performance

A benchmarkthe best in class results achieved by a competitor

New slide

The financial numbers are the product of a price and a quantity component:

Planned or Budgeted amount = standard price per unit * budgeted quantity

Actual amount = actual price per unit * actual quantity

Variance analysis explains the difference between planned and actual costs by evaluating:

Differences between planned and actual prices

Differences between planned and actual quantities

New slide

Managers focus separately on prices and quantities because in most organizations:

One department or division is responsible for the acquisition of a resource and

determining the actual price

A different department uses the resource and determines the quantity

A variance is a signal that is part of a control system for monitoring results and thus

variances provide a signal that operations did not go as planned.

Variance analysis helps managers understand the source of the differences

If managers learn that specific actions they took helped lower the actual costs, then they

can obtain further cost savings by repeating those actions on similar jobs in the future

If the factors causing actual costs to be higher than expected can be identified, then

actions may be taken to prevent those factors from recurring in the future

If cost changes are likely to be permanent, cost information can be updated for future jobs

The document summarizing costsvariously referred to as budgeted costs, estimated costs, projected

costs, target costs, or forecasted costs, but all identify the same costsis called the master budget.

The first level of variance analysis for a cost item focuses on the differences between actual

and estimated (master budget) costs for the item. The second level of variance analysis

decomposes the first-level variances into a flexible budget variance and a planning variance. The

flexible budget variance is the difference between actual costs and flexible budget costs, which

reflect the volume level achieved, rather than planned. The planning variance is the

difference between flexible budget costs and master budget costs. For variable costs, the third

level of variance analysis decomposes the flexible budget component of the second level

variance into efficiency (use) and price (rate) variances.

First-Level Variances

The first-level variance for a cost item is the difference between the actual costs and

the master budget costs for that cost item

Variances are favorable (F) if the actual costs are less than estimated master budget

costs

Unfavorable (U) variances arise when actual costs exceed estimated master budget

costs

Decomposing the Variances

A flexible budget adjusts the forecast in the master budget for the difference between

planned volume and actual volume

Cost differences between the master and the flexible budget are called planning

variances

Reflect the difference between planned output and actual output

Arise entirely because the planned volume of activity was not realized

Flexible budget variances are the differences between the flexible budget and the

actual results

Flexible budget variances reflect:

Quantity variancesthe difference between the planned and the actual use rates

per unit of output

Cost variancesthe difference between the planned and the actual price or cost

per unit of the various cost items

The second-level variances are the planning variance and the flexible budget

variance

The direct material flexible budget variances and direct labor flexible budget variances can

be decomposed further into third-level variances:

Efficiency variances

Price variances

By classifying flexible budget variances into rate (price) and efficiency (quantity)

variances, managers can better understand the factors causing those variances and

correct the standards or institute changes that help reduce expenses

Quantity variance = (AQ - SQ) x SP

Where:

AQ = actual quantity of materials used

SQ = standard quantity of materials allowed

SP = standard price of materials

New slide

Price variance = (AP - SP) x AQ

Where:

AP = actual price of materials

SP = standard price of materials

AQ = actual quantity of materials used

The price variance may be calculated using the quantity purchased rather than the

quantity used

When the amount of raw material used is different from the amount of raw material purchased,

we define one more variable PQ (the actual quantity of raw material purchased)

Total Cost: The actual cost of the acquired raw materials = purchased quantity (PQ) x actual price (AP).

Price Adjusted Cost: The cost of acquired materials using the standard price = purchased quantity (PQ) x

standard price (SP).

Price Adjusted Quantity: The cost of materials used using the standard price = quantity used (AQ) x

standard price (SP).

Flexible Budget Cost: The cost of the standard quantity of materials = standard quantity (SQ) x standard

price (SP).

Rate variance = (AR - SR) x AH

Where:

AH = actual number of direct labor hours

AR = actual wage rate

SR = standard rate

SH = standard number of direct labor hours allowed

The sum of the rate variance and the efficiency variance equals the total flexible

budget direct labor variance

(budgeted)

Material 15,000 pounds $6/ pound 30 pound/ unit 7$/ pound

purchased

DL 2,000h $10/h 4h/ unit $11/h

Units produced 500

Material used 12,500 pounds

(PQ)

Required

(a) Determine the material price variance based on the quantity of materials purchased.

(b) Determine the material quantity variance.

(c) Determine the direct labor rate variance.

(d) Determine the direct labor efficiency variance.

a. Because the quantity purchased differs from the quantity used, the material price variance

uses the purchased quantity (PQ) instead of the quantity used (AQ).

Material price variance = (AP SP) PQ

Material price variance = ($6 $7) 15,000 = (15,000)

b. Material quantity variance = (AQ - SQ) x SP

Material quantity variance = (12,500 (500x30)) x $7 = (17,500)

= ($10- $11) x 2,000 = (2,000)

= (2,000 (500x4)) x $11 = 0

10-46

Pharout Company uses a standard cost system. Job 007 is for the manufacturing of 1000 units of the

product X. The companys standards for one unit of product X are as follows:

Quantity Price

DM 10 ounces $5/ ounce

DL 5 hours $10/ h

The job required 9,800 ounces of raw material costing $58,800. A favorable labor rate variance of $2,250

and an unfavorable labor efficiency variance of $1,000 also were determined for this job.

(a) Determine the direct material price variance for job 007 based on the actual quantity of

materials used.

(b) Determine the direct material quantity variance for job 007 based on the actual quantity of

materials used.

(c) Determine the actual quantity of direct labor hours used on job 007.

(d) Determine the actual labor costs incurred for job 007.

= [(58,800/9,800) 5] x 9,800

= (6 - 5) x 9,800 = 9,800

= (9,800 (10x1,000))x 5

= (1000)

c. To get AH

Direct efficiency variance = (AH - SH) x SR

1000 = (AH- (5x1000)) x 10

100 = AH 5,000

5,100 = AH

AH = 5,100

(2,250) = (AR 10) x 5,100

AR = 9.55

10-47 Each unit of Product B has standard requirements of 8 pounds of raw material at a price of $25 per

pound and 1 hour of direct labor at $12 per hour. To produce 20,000 units of this product, product B

actually required 18, 000 pounds of the raw material costing $27 per pound. The job used a total of 18,000

direct labor hours costing a total of $198,000.

Required

(a) Determine the material price variance for product B.

(b) Determine the material quantity variance for product B.

c) Assume that the materials used on this job were purchased from a new supplier. Would you

recommend continuing with this new supplier? Why or why not?

(d) Determine the direct labor rate variance for product B.

(e) Determine the direct labor efficiency variance for product B.

= (27 25) x 180,000 = 360,000

= (180,000 (20,000 x 8)) = 20,000

d. Direct labor rate variance = (AR - SR) x AH

= (11 12) x 18,000

= (18,000) F

= ( 18,000 - 20,000) x 12

= (24,000) F

10-48 Assembly of product P13 requires two unit of component X, one units of component Y, and two units

of component Z. Job J372 produced 220 units of P13. The following information pertains to material

variances for this job, analyzed by component:

Components

X Y Z

Price variance 1000 U 750 F 450 U

Quantity Variance 2500 U 1000 U 800 F

The actual material prices were $2 more, $3 less, and $1.5 more per unit for components X, Y, and Z,

respectively, than their standard material prices per unit.

Required

(a) Determine the number of materials units consumed of each type of component.

(b) Determine the standard materials price per unit of each type of component.

AQ for X = 1000/ 2 = 500

AQ for Y = -750 / -3 = 250

AQ for Z = 450 / 1.5 = 300

SP for Y = (250 (1x200)) / 1000 = $0.05

SP for Z = (300 - (2x200)) / -800 = $0.125

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