LEARNING OBJECTIVES After studying Chapter 12, you should be able to: Lon Compute the direct materials price and quantity variances and explain their significance, Loz Compute the direct labor rate and. efficiency variances and ‘explain their significance. Los Compute the variable manufacturing overhead rate and efficiency variances. Loa (Appendix 124) Compute and interpret the fixed overhead budget and volume Los (Appendix 128) fepare journal entries to record standard ‘costs and variances. Standard Costs and Variances a a Managing Materials and Labor Bharac Heavy Electricals Limited (BHEL), a leader in the Indian power equip- ment with market capitalization of USS21 billion, faced price pressures on raw materials in financial year (FY) 2009 that resulted! in a 2% erosion of margins in the frst half of that year. Its margin had been cushioned by its fixed price contracts, which constituted 50% of its portfolio, leaving the remaining half under a price variance clause. BHEL also suffered a significant one-off vorable labor rate variance of USS383 million that was related to wage revision and an increase in gratuity payment threshold limit. Consequently, FY2009 EBITDA (earnings before interest, axes, depreciation, and amortization) mar- gins fell from 19.6% in FY 2008 to 15.9%, Learning from its underlying prob- lems, BHEL carefully managed its business and material and labor costs, and 25% to USS7.3 billion with an improved inereased its revenue in FY2010 by EBITDA margin of 18.29%. Sources “Fitch Ratings Has Today Affirmed India-Based Bharat Heavy Electricals Lis National Long-Term Rating at ‘AAAGind).” Reuters, June 25, 2009: and Businessweek.com, May 28, 2011580 Colonial Pewter Company Chapter 12 in the last chap ance measures er red performance Per yese variances Provide ‘e encountered Pr audgt variances. Tese variances Provide di we imestigated Me eganization performed in atsnigg ring how well feedback concer fecha gout ax expressed i ee PUAEE ‘The overall net operating fe financial goals as expre change in activity had on prof aapact any change in activity sa what impact Ma revenues and Costs WETE CONTOled fp ate how wel whey wieate How an got even more detail IbOUt how yg come setiity vena ites revere and spending varias the cae of many of he peri k's Harting. an unfvrable sending ag cn wee coed Fors LT ay ai a sc ring spt OPE ube te oa aoe i ee earically i dffereat people SIC Po thon on erent Ss Fe hes wl ee om hin ede fg Sipps an for purchasing th. ns Ca re no two pars Secon muy eee soem PO ena we 2 That mensres how wel sours WIE used and a pat how wel Nearer tthe esoners were conolled. The spendlng varianess Ins bag often referenced as the total flexible variances i in other source’. ‘standards enchmakfr essing etoanc. Standards round veh : Semel nisi Specific lor time standards forthe completion of etn ass, such as installing cary en a a a hw noche pal SEE ea dumie ooo ae eee Te Ee ae for rihes rhe ioce enceeieei tins aaa ae 4. Da: I've gota feeling that we aren't getting the production we should out of our ne people. an aveful lot of materiah—=Standard Costs and Variances S81 om: What about the shipment of detective ‘ago—the one with the iron contaminatio Janet: That’s ancient history. How was Ito ky deal J. D.: Calm down everybody. Let's get the facts cach other. Tom: agree. The more facts the better, J.D. Okay, Terr, i's your turn, Facts are the controller's department. Terry: V'm afraid | ean't provide the answers off the top of my head, but it won't take me {oo long to set up a system that can routinely answer questions relating to worker productivity, material waste, and input prices, J.D: How long is “not too long Terry: | will need all of your cooperation, but how about a week from today? J.D: That's okay with me. What about everyone else? Tom: Sure Janet: Fine with me. J.D. Let’s mark it on our calendars. MATERIALS COST OF MICROSOFT XBOX ONE AND SONY PLAYSTATION 4 RE though home geming consoles are dominated by afew players, ther efforts to control the raw material costs are intense. According to preliminary results from the Teardown Analysis Service at IHS ie. which is listed on the New York Stock Exchange, the production cost for Microsoft Xbox One was $471 per unt with its bill of materials (@0M) accounting for 97% of the product cost at $457 and manufacturing costs at $14 per unt. For Sony PiayStation 4, the production cost was. «estimated to be $381 with BOM accounting for 97.6% of the cost at $372 with manufacturing costs at $9 per unit. The higher standard product cost for Xbox comes mainly from the Kinect whch had a BOM of $75. However, with technology advancement, diferent stages o ife cycle, and mproved learning curve inthe production processes, these standard costs are expected to reduce overtime. ‘Souces IMS Pressroom, “Sony Nears Breskevn Pit on PlyStaton 4 Hardware Costs," November 19, 2013; and “Merosofe Xbox One Haaware Cost Comes in Bon Rta Price, MS Teardown Reveals” November 26,2013, ET Setting Direct Materials Standards Terry Sherman's first task was to prepare price and quantity standards forthe company’s only signiieant raw material, pewter ingots. The standard price per unit for direct materials should reflect the find, delivered cost ofthe materials. After consulting with purchasing manager Janet Warner, Tetry set the standard price of pewter at $4.00 per pound, “The standard quantity per unit for direct materials should reflect the amount of material required for each unit of finished product as wel a an allowance for unavoid- able wast." After consulting with the production manager, Tom Kuchel, Terry set the ‘quantity standard for pewter at 3.0 pounds per par of statues. Pewter that you bought a couple of months ? That caused us major problems. snow it was off-prade? Besides, it was a great before we start sinking our fangs into Although alowances for waste spas, and rejects ae fen bit it tana hip practice is ofen eicied bees contacts the Zero defects gol tal underlies many process improvernent Prams allman wae spol, nd ess uti he andar so te allovances ‘Would be periodically reviewed and reduced over met reflec mproned proc hater equipment582 Chapter 12 SETTING NEW RAW warefaL cost STANDARDS THROUGH HEDGING. i tat cbt rol Ronen may ee esl prt evoseve pat ott ens a eco ga ore eon el bec ad be 3 do . Cl fue! at an assured price to prote il le geo Po tea hey wal be contactual bound o ay for ol at higher en one tay anes wre baby afc y ef Neiges we ol rs ‘sharply Ina single quarter, Alaska, American, Continental Delta, Southwest, anil lost ver USSI.5 billon nue hedgg. Silay, Meri Lynch estimated hat 2008, Carers elu, hz Chea, Chaa Eastern, Cathay Pact, Sngaore Aries, Share ‘and Thai Airways, would report a total of US$3.8 bilion losses related to fuel hedging. Sauces: “Fuel Hedges Prove os Canter Asan ios" uses Times, RUB 8, 2008; a Graham Dunn, ‘Fuel Hedging,” Fightecba, February 19, 2009. Once Terry established the price and quantity standards he computed the standard cost ‘material per statue of the finished product as follows: 30 pounds per statue X $4.00 per pound = $12.00 per statue This $12.00 cost will appear on the products standard cost card Setting Direct Labor Standards Direct labor price and quantity standards are usually expressed in terms ofa labor rat and labor-hours. The standard rate per hour for direct labor should include hourly wage ‘employment taxes, and fringe benefits. Using wage records an production manager, Terry Sherman determined the standard rate per direct labor-hour be $22.00. ‘Many companies prepare a single standard rate per hour for all employees i department. This standard rate reflects the expected “mix” of workers, even though th actual wage rates may vary somewhat from individual to individual due to differing skill or seniority The standard diet labor time required o complet a unit of product (called the stand hhours per unit) is perhaps the single most dificult standard to detenmine, One approach ‘break dvin each task into elemental body movements (such as reaching, pushing, and tua ‘over. Published tbls of standard times For such movements can be use to esate th 1 tm required to complet the task. Another approach is for an industrial engineer to doa tim and motion study, actually clocking the time required foreach tsk, In this chaptet, assume that “tight but atainable” labor standards which includ allowances for break sonal msds femplyes, cap and machine dovnine le consulting with the production manager, ‘Te standard for direct as time at 50 areas St and edie Once Terry established the rate and time standards, he compu labor cost per unit of product as follows: fa jputed the standard (0,50 direct labor-hours per state X $22.00 per di 11,00 per statue This $11.00 per statue standard direct labor cost aon, rials Of the standard cost card for a pair of pewter aac oe4 I Standard Costs and Vanances THE SIGNIFICANCE OF MATERIALS ND LABOR VARIANCES Scarce: Hrushesh Mohanty, “Raw matenl price es seas 3 reatenshandoom sector” Business Stan, Jamar) Setting Variable Manufacturing Overhead Standards As with direct labor, the price and quantity standards cvethead are usually expressed in terms of rate and hours. The rate represents the sariable portion of the predetermined overhead rate discussed inthe job order cont ing chapter; the hours relate to the activity base that is used to apply overtead to units of product (usually machine-hours or direct labor-hours). At Colonial Pewter, the vati- ble portion of the predetermined overhead rate is $6.00 per direct labor-hour. Therefore, Tesry computed the standard variable manufacturing overhead cost per statue as follows: (0,30 ditectlabor-hours per statue % $6.00 per direct labor-hour ~ $3.00 per statue This $3.00 per statue cost for variable manufacturing overhead appears along with direct materials and direct labor on the standard cost card in Exhibit 12-1. Observe that the ward cost per unit for variable manufacturing overhead is computed the same way «for direct materials or direct labor—the standard quantity allowed per unit of the out pu is multiplied by the standard price. In this case, the standard quantity is expressed as 105 direct labor-hours per statue and the standard price (or rate) is expressed as $6.00 per uieet Tabor-houe, for variable manufacturing m @) Standard Standard Standard uantty Pree Cost, Inputs or Hours orate (1) @) Dect materials 30 pounds $4.00 per pound $12.00 Dirt abor : asohous — $2200perhour 11.00, a osonous — $6.00perhow — _ 3.00 | ove | ‘Total standard cost per statu $26.00 EXHIBIT 12-1 Standard Cost Card—vanable Manufacturing Costs584 Chapter 12 ‘The standard costs of $12.00 per statue for mater® “vanes sisson ranma atc wed compa aad sone ane ee a For june ix shown in Exhibit 12-2. Nota, ier exe at pean ey pie ence Et tas Teor ince an atv are erformance repr is based onthe Owing da Originatly budget output in une et 2.000 st Actual ouput inne «= a. ei ‘Actual cirect materials cost in one Dine $26 ‘Actual direct labor cost June. =e 0 ‘Actual variable manufacturing overhead cost in June $7,140 There were no beginning or ending rventoros of raw materials n June; Materials purchased were used For example, the diet tor cos Tor the planing budeet in Exhibit 12-2 S28 penance mportin Exit 12-2 suse ould be eNen more a ita penng anaes could be broken down no thst prierelted and felted components ar xampl the die mates spends variance in he So uni mean ha given the ata evel of proton or the pe ieee much sx were to igh y $700 east occording to the standard Wi th eto ngher tan ext pce or eis? Oras i Oe to Insta bangs? The stand cos anaes we wl be iscsi in he et Shaper ae dsignedo answer thse question EXHIBIT 12-2 Flexible Budget Performance Report for Manufacturing Costs Statues produced (9) .. ‘materials ($12.00) ‘Variable manutacturing overhead ($3.09) c $6800 $300F $6,000 $1,140. Colonial Pewter Flexible Budget Performance Report Manufacturing Costs Only For the Month Ended June 30 Planning Activity Flexible Spending Budget Variances Budget Variances 2,100 2,000 $25200 $1,200F $24,000 $700 $23,100 $1,100F $22,000 $680U | A cone mode fr standard Cost Varnes Anais Standard cos variance analysis decomposes spending variances from the Rxible bud ito two elements—one due othe price paid for he input and the other due to the ofthe input that is used. A price variance isthe difference between the actual paid for an input and the standard amount that should have been paid, multiplied by setual amount ofthe input purchased. A quantity variance isthe difference between ho much of an input was actually used and how much should have been used and is statedil dollar terms using the standard price ofthe input.‘Standard Costs and Variances Why are standards separated into two. ‘alezories—price and quantity? Price variances and. juntty variances usually have different i ‘causes. In addition, diferent managers are usually For example inthe ease ofa raw material, the pur- Ebi ance fora variable cost into a price variance anda quantity variance? Colon cin ts cx coresponds with the Actual Results cohumn in Exhibit 12-2 Column (3) coresponds wah the Flexible Budget column in Exhibit 12-2, Column (2) has been inserted into Exlabit 12-49 enable separating the spending variance in@frice vance and a quantly varenee Three things shouldbe noted from Exhibit 12-3 Rise ‘nance and a quantity variance fr each ofthe thee va {et abor, and variable manufacturing overhe: sams A price variance is called a materials price variance in the ease of direct materials, & labor rate variance inthe case of direct labor, anda variable overhead rae variance inthe 6,500 pounds), This variance is labeled favorable (F) because the actual Purchase price per pound is les than the standard purchase price per pound. A price ‘atiance is labeled unfavorable (U) if the actual purchase price exceeds the standard Purchase price. a a ‘Generally speaking, th preasing managers conto overthe prize aid or soak ani therefore responsible fo theaters pre vrianes, Many factors nunc the ices pat for goods inluding how many ums are dre ow the ode delivered, ster the ender sa rash ode, ard the quality of materials purchased any of these far devas fom what was asumed whe he standards were sel pice rants can ‘sult Fr example, purchasing sevom-grade materials ates than top gad materials ray result an favre pie variance bees the Tower grade matras maybe les costly. However, the lower-grade materials may create production pro so ears 587588 Chapter 12 iger could be responsible: c other than the pure lems beyond the pure ch trace he The Materials Quantity Variance rerence between the $26,000 in column (2) ° ee (denoted by U). The ee ae in product soma e's sh a er unit of ials, It is labeled as unfavorable (favorable) when the actual qu ‘To understand the materials quantity variance, note that the actual amount of 1S FAVORABLE VARIANCE ALWAYS GOOD? ‘hen Tata Motors lst $110 miton n 2000, the company's executives mandated a 10%: in costs, Tatas purchasing managers responded by using reverse auctions to buy ra ma Reverse auctions require supplies to bid to Tata Motos. The supplier who place pene ts May evetuay be offset by greater Scrap, rework, waranty customer complaints, and lost sales, ‘S428 Fyn Mere, Te et Pop's Cr Fores, hn 16, 2007, p. 70-74 MANAGING MATERIALS PRICE. VARIANCES Mosaics ch 518 Noun 2010, nay es Sept ra ol ar asses peg ee vie Use ma heer ree the prices of their products. ; rcs raed te orce ie oe tess ea Nat a1 ZU Sma, nae eet Foc Penland! 120 restarans on ne es FE © addressed the competition and profit Challenge | keh eel ines 2 eames cogent CHO races ae wal sean especially on its breakfast menu, KFC als ee ote oor eh a ee Eb Naber me tse ee ERE esa Clearly with many ‘methods of copir aan eno Ser heme ean te einen nett ne ee efficiency vStandard Costs and Variances 589 this calulation? The production manager is oninaily responsibl it is ordinarily responsible for the quantity arian, he actual Price were used in the calculation ofthe quantity valance, the pe, mnager's performance evaluation would be unfairly inuenced by the efheien or inelticieney of the purchasing manager, fae Excessive materials usaj machines, inferior materials qu aly sf 'ge can result from many factors, Wwality, untrained workers, and poor Gener- supervision. Gener aking. itis the responsibility of the production manager to see that material usige is Kept in Tine with standards. There may he ag manager is responsible for an unfavorable mater ple i the purchasing manager buys inferior materia vay be unsuitable for use and may result in exces mnanager rather than the production manager would be responsible for the quantity Thus far, we have shown how to compute direct materials variances using the general tvodel depicted in Exhibit 12-4; however, these variances can also be ealculated using tsi mathematical equations. Exhibit 12-5 shows how Colonial Pewter ean compute is sinect materials varianees using the equations-based approach, including faulty EXHIBIT 12-5 Peale revel Drect Materials Variances: The Materials price variance = (AQ x AP) ~ (Aa x SP) Equations Based Asproach Materials price variance = AQ(AP - SP) Materials price variance = 6,500 pounds ($3.80 per pound — $4.00 per pound) Materials price variance = $1,900 F ‘Materials Quantity Variance: Materials quantity variance = (AQ x SP) — (SQ x SP) Materials quantity variance = SP(AQ ~ SQ) Materials quantity variance = $4.00 per pound (6,500 pounds ~ 6,000 pounds) Materials quantity variance = $2,000 U where: AQ = Actual quantity of pounds purchased and used in production ‘SQ = Standard quantity of pounds allowed for the actual output, AP = Actual prica per unit ofthe input ‘ ‘SP = Standard price per unit of the input wre, Using Standard Costs—Direct Labor Variances. | wiarnenemcmee oe: Ee Perea el ere oe In adlon, Colonial Peters records fr June showed that 1.050 dist lbochous, _ Shewee St actly ered Ge tha fe compay pul ts ie ior woke tl of Sean Cael pio te od et raat be mamdanicocs rk ecirine cigmeae ote amerpr meee enh Exhibit 12-1, Terry computed the direct labor rate and effi ip inn 12-6 2-6 ar the same os those used Notice that the column headings in Exhibit 12-6 ef aise Exhibits 12-3 and 12-4, except that in Exhibit 12-6 the terms rare Place ofthe terms price and quantityGupte 12 someone other si Id be emphasizing the purchasing. manager coul muxerials price —— a ae ae ction problems beyond the manaser coals the Tchast ing manager may have to use express deli cases, the prodaction manager should be held responsible for the resulting price The Materials Quantity Variance tween the $26,000 in column Referring agaii it 12-4, the difference be! the rer mre the materials quantity variance of $2,000, which is 3s unfavorable (denoted by U). The materials quantity variance measures erence between the actual quantity of materi pro hamtity of mentexials sTknwed Kar Gevactes! ODO multiplied by the stan sr unit of materials. It is labeled as unfavorable (favorable) when the actual material used in production is greater than (less than) the quantity of mat wuld have been used according to the standard. To understand the materials quantity variance, note that the actual amount of, 1 in production was 6,500 pounds. However, the standard amount of pewter all he actual output is 6,000 pounds. Therefore, too much pewter was used to ictual output—by a total of 500 pounds. To express this in dollar terms, ds is multiplied by the standard price of $4.00 per pound to yield the quanti of $2,000 U. Why is the standard price of pewter, rather than the actual pri 'ORABLE VARIANCE ALWAYS GOOD? 3 Motors lost $110 million in 2000, the company's executives mandated a 10% Tata's purchasing managers responded by using reverse auctions to buy raw uchons require suppliers to bid against one another for the right to sell raw tors. The supplier who places the lowest bid wins the contract. Tata's590 Chapter 12 EXHIBIT 12-6 ‘Standard Cost Variance Aralysis—Direct Labor q) Actual Hours of input, at Actual Rate @) @) ‘Actual Hours Standard Hours of input, Allowed for Actual Output, at Standard Rate at Standard Rate (AH x SR) (SH x SR) ‘The spending variance in this book is oten referenced as the total exible variance in other sources The Labor Rate Variance Using the $23,100 total cot figure in column (2) of Exhibit 12-6, we ean make two Parisons—one with the foal cost of $22,680 in column (1) and one with the total $22,000 in column (3). The difference between the 2.680 in column (1) and the $23, in column (2)is the fabor rate variance of $420 F. The labor rate variance meas difference between the aetual hourly rate and the tandard hourly rate, multiplied by acta nomber of hours worked during the petio. ‘To understand the labor rate variance, note that the actual hourly rate of $21 0.40 ess than the standard rate of $22.00 per hour. Because 1,080 hours were worked, the total amount of the variance is $420 (= $0.40 per hour % 1,050 hours). \aiance is labeled favorable (F) because the setual hourly rate is less than the s hourly rate I the actual hourly rate had been greater than the standard hourly variance would have been labeled unfavorable (U), rate variances can arise based on how production supervisors use their direct labor Skilled workers with high hourly rates of pay may be given duties that require litle skill call for lower hourly rates of pay. This will result in an unfavorable labor rate ari because the actual hourly rate of pay will eeced the standard rate specified forthe p task. In contrast a favorable rate variance would result when workers who are paid at a ‘ower than specified inthe standard are assigned to the task. However, the low-paid ers may not be as efficient. Finally, overtime work at premium rates will result in an unt able labor rate variance if the overtime premium is charged to the direct labor account The Labor Efficiency Variance Referring back to Exhibit 12-6, the diference between the 23,100 in column (2) the $22,00 in column (3) isthe labor efcieney variance of 1.100 untaverabe (0). labor effcieney variance measures the diference between the actual hours used and Sard hours allowed for the actual output, miplied by the standard hourly rae, ‘To understand Colonial Pewter’ labor effcieney variance, note that the atl ‘thous used n production was 1,050 hous However the standard amount of he it is 1.000 hours. Therefore, the company used 0 more hous for ‘tual output than the standard allo. To express this in dollar terms, the 80 hors ae pled by the standard rae of $22.00 per hour to vield the eciency variance of S100 UsStandord Costs and Variances sor MANAGING UNFAVORABLE LABOR RATE VARIANCES «vent nthe news 2010 de othe adverse publicity caused by the sen orkers at ts is Foxcorn, wich sited Foxconn hag to cane ats 8 000 (US$308) per month at its Shenzhen p 2010. Workers of Hondas Chinese plans held multiple st fermand for higher pay. Strkes also Cokie a ier at of Ch ng aeninegr acer ee eee lnresponse fo increasing labor shortage and rising costs in China’ coastal areas, many coastal rmanulactirers are shifting part of thei operations overseas, n particular, appael to Bangladesh and ‘ootweat to Vietnam. n fact, many more manufacturers, including Foxcom and Intel, are moving their operations into island China, to places such as Zhengzhou (Henan province), Ganzhou Langx: brome), and Chengdu and Chengeing (Sichuan provncel. Notably the minimum month wages are sch higher in China's ona aes {e851 35-USS168) than and (US$95-USS1 1), a well as 9 nearby competing countries such as Vietnam, Bangladesh, and Cambodia where the average month sage rom USS37t USS Dest elo ages nae nes many antares ioose to stay in China because of its developed supply chain supports ‘outce: "China's Chain Reacton,” Reuters, August 2010. SE Possible cases of an unfavorable bor efceny variance include poly tained or ioe Workers poor-quality materials, requiring ore aor uy ep Casing breakdowns and work itemuptions poor superison f worker and nacurats Sundar The manages charge of rodaton woud usualy be esponsbl ocone othe bor efficiency variance However, he purchasing manager sul De el pon “ive he purchase of poor quali materials eed in excessive labor rocesing me Another important case ofa unfavorable abr eeny vance may bes cont demand fr the eompany’s prodits, Managers in some Compan age that ict an perhaps une, o constant ajst te wore nespons to changes n the amount of work that needs tobe done. n sch companies, te Gt ior workforce scaly fixed the shot un. I demande inset o Keep enero, worker sro ad of and an unfavorable labor fiency variance wl oe be ord Uenstomer ender nse kp x Be wort cee mages \woopourether sce an unter iar fice tance oldie Ace “iain Pens tine wean eee Todidea Excenve iene -patelry workin poss iveog—ieade high det Tc, sbslte woods nl ineficent operation. As asesequence, when the works CASHIERS FACE THE STOPWATCH Ouran Woktoce Optimaton ONO) wes sofware tat es ergnered aor snarls {a determine tow fong it should take @ cashier to check ut a customer, The software measures an employee's productivity by contnuously comparing actual customer checkout times to pee- fstabihed labor effsency standards. For example the casirs at Mele, 2 regions etaier located nthe Mist, may be demoted or terinatdf they do rot mest or exceed bor af lency standards for atleast 95% of customers served ln ation fo Wee. OWO has atacted Ate cents such as Gap, Lined Brands, Ofice Det Nk, and Tvs" Us based on cams Sats sofware ean reduce labor costs by 5-15% The sforarefas aso atraced ne tenor ot ‘he United Food and Commercial Workers Urion, wich represents 27,000 Meer ‘union has fled @ grievance against Meier related tots caster montonng ss Src. Vanessa OComel, Stores Count Seconds to Cut Labor Casts” The Wal Sweet Jorma, November 17,2008, pp AL-AL. |Managerial Accounting LU ae Sa a ea ia ee NEP Bo a) KATHERINE C. K. YUEN