Performance Evaluation Using Variances From Standard Costs: Budgeting

Performance
Performance Evaluation Using

Evaluation Variances
Using
Budgeting
Cost Behavior and Cost-Volume-Profit Analysis
from Standard Costs
Variances from Standard Costs
11e
Principles of Managerial Accounting
Chapter 7
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
Reeve Warren Duchac

© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Learning Objectives
1. Describe the types of standards and how they are
established.
2. Describe and illustrate how standards are used in
budgeting.
3. Compute and interpret direct materials and
direct labor variances.
4. Compute and interpret factory overhead
controllable and volume variances.
Learning Objectives
5. Journalize the entries for recording standards in
the accounts and prepare an income statement
that includes variances from standard.
6. Describe and provide examples of nonfinancial
performance measures.
Learning Objective 1
Describe the types

of standards and
how they are
established.
LO 1
Standards
 Standards are performance goals. Manufacturing
companies normally use standard cost for each of
the three following product costs:
1. Direct materials
2. Direct labor
3. Factory overhead
LO 1
Standards
 Accounting systems that use standards for
product costs are called standard cost systems.
 Standard cost systems enable management to
determine the following:
 How much a product should cost (standard cost)
 How much it does cost (actual cost)
LO 1
Standards
 When actual costs are compared with standard
costs, only the exceptions or variances are
reported for cost control. This reporting by the
principle of exceptions allows management to
focus on correcting the cost variances.
LO 1
Setting Standards
 The standard-setting process normally requires
the joint efforts of accountants, engineers, and
other management personnel.
LO 1
Types of Standards
 Unrealistic standards that can be achieved only
under perfect operating conditions (such as no
idle time, no machine breakdowns, and no
materials spoilage) are called ideal standards or
theoretical standards.
LO 1
Types of Standards
 Currently attainable standards, sometimes called
normal standards, can be attained with reasonable
effort. Such standards, which are used by most
companies, allow for normal production
difficulties and mistakes.
LO 1
Reviewing and Revising Standards

 Standard costs should be periodically reviewed to
ensure that they reflect current operating
conditions. Standards should not be revised,
however, just because they differ from actual
costs.
LO 1
Criticisms of Standard Costs

 Standards limit operating improvements by
discouraging improvement beyond the standard.
 Standards are too difficult to maintain in a
dynamic manufacturing environment, resulting
in “stale standards.”
 Standards can cause workers to lose sight of the
larger objectives of the organization by focusing
only on efficiency improvements.
LO 1
Criticisms of Standard Costs

 Standards can cause workers to unduly focus on
their own operations to the possible harm of other
operations that rely on them.
Describe and
illustrate how
standards are used in
budgeting.
LO 2
Budgetary Performance Evaluation

 The standard cost per unit for direct materials,
direct labor, and factory overhead is computed as
follows:
Standard Standard Standard
x
Cost Per Unit = Price Quantity
LO 2
Budgetary Performance Evaluation

Western Rider’s standard costs per unit for XL
jeans are shown in Exhibit 1.
LO 2
Budget Performance Report

 The report that summarizes actual costs,
standard costs, and the differences for the units
produced is called a budget performance report.
LO 2

 The differences between actual and standard
costs are called costs variances.
 A favorable cost variance occurs when the actual
cost is less than the standard cost (at actual
volumes).
 An unfavorable cost variance occurs when the
actual cost exceeds the standard cost.
LO 2
LO 2
Manufacturing Cost Variances

 The total manufacturing cost variance is the
difference between total standard costs and total
actual costs for the units produced.
 For control purposes, each product cost variance
is separated into two additional variances as
shown in Exhibit 3 (next slide).
LO 2
LO 2

 The total direct materials variance is separated
into a price and quantity variance.
Price Difference + Quantity Difference

LO 2

 The total direct labor variance is separated into a
rate and a time variance.
Rate Difference + Time Difference

Compute and
interpret direct
materials and direct
labor variances.
LO 3
Direct Materials Variances

During June, Western Rider reported an
unfavorable total direct materials cost variance of
$2,650 for the production of 5,000 XL style
jeans, as shown in Exhibit 2 and reproduced
below.
LO 3
Direct Materials Variances

Actual Direct Materials Cost = Actual Price x Actual Quantity
Actual Direct Materials Cost = ($5.50 per sq. yard) x (7,300 sq. yards.)
Actual Direct Materials Cost = $40,150
Standard Direct Materials Cost = Standard Price x Standard Quantity
Standard Direct Materials Cost = ($5.00 per sq. yard) x (7,500 sq. yards.)
Standard Direct Materials Cost = $37,500
Actual costs ($40,150) – Standard costs ($37,500) = $2,650
Total Unfavorable
Materials Variance
LO 3
Direct Materials Price Variance
Direct Materials Price Variance = (Actual Price – Standard Price) x

Actual Quantity
Direct Materials Price Variance = ($5.50 – $5.00) x 7,300 sq.
yds.
Direct Materials Price Variance = $3,650
Unfavorable direct
materials price
variance
Western
Western Rider
Riderpaid
paid $0.50
$0.50 more
more per
per
square
square yard
yard of
of material
material than
than the
the standard.
standard.
LO 3
Direct Materials Quantity Variance
Direct Materials Quantity Variance = (Actual Quantity –

Standard Quantity) x Standard Price
Direct Materials Quantity Variance = (7,300 sq. yds. – 7,500
sq. yds.) x $5.00
Direct Materials Quantity Variance = – $1,000
Favorable direct
materials quantity
Western
Western Rider
Rider used
used 200
200 variance
square
square yards
yards less
less than
than the
the
standard.
standard.
LO 3
Direct Materials Variance Relationships
 The relationship among the total direct materials

cost variance, the direct materials price variance,
and the direct materials quantity variance is
shown in an animated reproduction of Exhibit 4
in the next slide.
LO 3
Direct Materials Variance Relationships
Actual cost: Standard cost:

Actual quantity x Actual quantity x Standard quantity
Actual price Standard price x Standard price
7,300 x $5.50 = 7,300 x $5.00 = 7,500 x $5.00 =
$40,150 $36,500 $37,500
Direct materials Direct materials

price variance quantity variance
$3,650 U – $1,000 F
Total direct materials cost variance
$40,150 – $37,500 = $2,650 U
EE 7-1
LO 3
Direct Labor Variances

During June, Western Rider reported an unfavorable
total direct labor cost variance of $2,500 for the
production of 5,000 XL style jeans, as shown in
Exhibit 2 and reproduced below.
LO 3
Direct Labor Variances

Actual Direct Labor Cost = Actual Rate per Hour x Actual Time
Actual Direct Labor Cost = $10.00 per hr. x 3,850 hrs.
Actual Direct Labor Cost = $38,500
Standard Direct Labor Cost = Standard Rate per Hour x Standard Time
Standard Direct Labor Cost = $9.00 per hr. x 4,000 hrs.
Standard Direct Labor Cost = $36,000
Actual costs ($38,500) – Standard costs ($36,000) = $2,500
Total unfavorable direct

labor cost variance
LO 3
Direct Labor Rate Variance

Direct Labor Rate Variance = (Actual Rate per Hour – Standard Rate per
Hour) x Actual Hours
Direct Labor Rate Variance = ($10.00 – $9.00) x 3,850 hours
Direct Labor Rate Variance = $3,850
Unfavorable direct
labor rate variance
The
Theunfavorable
unfavorablevariance
variancecould
couldhave
have
been
beencaused
causedby
byimproper
improperscheduling
scheduling
and
anduse
useof
ofemployees.
employees.
LO 3
Direct Labor Time Variance

Direct Labor Time Variance = (Actual Direct Labor Hours -
Standard Direct Labor Hours)
x Standard Rate per Hour
Direct Labor Time Variance = (3,850 hours – 4,000 direct
labor hours) x $9.00
Direct Labor Time Variance = – $1,350
Favorable
IfIfthere
therehad
hadbeen
beenananunfavorable
unfavorabletime
time direct labor
variance,
variance,ititmight
mighthave
havebeen
beencaused
caused time variance
by
byaashortage
shortageof
ofskilled
skilledworkers.
workers.
LO 3
Direct Labor Variance Relationships

Actual cost: Standard cost:
Actual hours x Actual hours x Standard hours x
Actual rate Standard rate Standard rate
3,850 x $10 = 3,850 x $9 = 4,000 x $9 =
$38,500 $34,650 $36,000
Direct labor rate Direct labor time

variance variance
$3,850 U –$1,350 F
Total direct labor cost variance
$38,500 – $36,000 = $2,500 U
EE 7-2
Compute and
interpret factory
overhead
controllable volume
variances.
LO 4
Factory Overhead Variances

 Factory overhead costs are more difficult to
analyze than direct labor and materials costs.
This is because factory overhead costs have fixed
and variable cost elements.
LO 4
Factory Overhead Flexible Budget
LO 4
Budgeted Factory Overhead at

Normal Capacity
Factory Overhead Rate =
Normal Productive Capacity
$30,000
Factory Overhead Rate =
5,000 direct labor hours
Factory Overhead Rate = $6.00 per direct labor hour
LO 4
Budgeted Variable Overhead

at Normal Capacity
Variable Factory Overhead Rate =
$18,000
Variable Factory Overhead Rate =
Variable Factory Overhead Rate = $3.60 per direct labor hour
LO 4
Budgeted Fixed Overhead

at Normal Capacity
Fixed Factory Overhead Rate =
$12,000
Fixed Factory Overhead Rate =
Fixed Factory Overhead Rate = $2.40 per direct labor hour
LO 4
Variable Factory Overhead Controllable Variance
Variable Factory
Overhead Actual Variable – Budgeted Variable
Controllable = Factory Overhead
Factory Overhead
Variance
Variable
Standard Hours for
x Factory
Actual Units Produced Overhead
Rate
LO 4
 The budgeted variable factory overhead is the

standard variable overhead for the actual units
produced.
LO 4
Variable Factory
Overhead Controllable Actual Variable Budgeted Variable
Variance = – $14,400
Factory Overhead
Factory Overhead
Variable Factory
Overhead Controllable 4,000 direct labor hours x $3.60
Variance = $10,400 – $14,400
Variable Factory
Overhead Controllable
Variance = – $4,000 Favorable Variance
EE 7-3
LO 4
Fixed Factory Overhead Volume Variance
Fixed Factory Standard Standard Fixed

Overhead Hours for Hours for Factory
Volume = – x
100% of Actual Units Overhead
Variance Normal Produced Rate
Fixed Factory Capacity
Overhead 5,000 direct 4,000 direct
= – x $2.40
Volume labor hours labor hours
Variance
Fixed Factory
Overhead = $2,400 Unfavorable
Volume Variance
Variance
LO 4
LO 4
 An unfavorable volume variance may be due to

factors such as:
 Failure to maintain an even flow of work
 Machine breakdowns
 Work stoppages caused by lack of materials or skilled
labor
 Lack of enough sales orders to keep the factory
operating at normal capacity
EE 7-4
LO 4
Reporting Factory Overhead Variances
 A factory overhead cost variance report is useful

to management in controlling factory overhead
costs.
 Exhibit 8 (next slide) illustrates this report for
Western Rider Inc. for June.
LO 4
Reporting Factory Overhead Variances
LO 4
Factory Overhead Account

Applied
Factory Standard Hours for Total Factory
= x
Overhead Actual Units Produced Overhead Rate
Applied 5,000 jeans x 0.80

Factory = direct labor hr. per pair x $6.00
Overhead of jeans
Applied
Factory = 4,000 direct labor hrs. x $6.00 = $24,000
Overhead
LO 4
Total Factory Overhead Actual Factory Applied Factory

= –
Cost Variance Overhead Overhead
Standard Hours for x Total Factory

Actual Units Produced Overhead Rate
LO 4
Total Factory Overhead Actual Factory Applied Factory

= –
Cost Variance Overhead Overhead
5,000 jeans x 0.80

x $6.00
direct labor hr. per
pair of jeans
LO 4
Total Factory Overhead Actual Factory

= – $24,000
Cost Variance Overhead
5,000 jeans x 0.80

x $6.00
direct labor hr. per
pair of jeans
LO 4
Total Factory Overhead Actual Factory

= – $24,000
Cost Variance Overhead
Total Factory Overhead $22,400 – $24,000

=
Cost Variance
Total Factory Overhead – $1,600 Favorable Variance

=
Cost Variance
LO 4

 Underapplied and overapplied factory overhead
account balances represent the following total
factory overhead cost variances:
 Underapplied Factory Overhead = Unfavorable Total
Factory Overhead Cost Variance
 Overapplied Factory Overhead = Favorable Total
Factory Overhead Cost Variance
LO 4
Factory Overhead
Actual factory Applied factory

overhead overhead 24,000
22,400
$10,400 + $12,000 4,000 hours x $6.00 per hour
LO 4
Factory Overhead
Actual factory Applied factory

overhead overhead 24,000
22,400
Balance, June 30 1,600
Overapplied
factory
overhead
LO 4

Actual factory overhead $22,400 Applied factory overhead $24,000
Budgeted Factory
Overhead for Amount
Produced
Actual Factory Applied Factory
Overhead Overhead
Variable factory OH $14,400
$22,400 Fixed factory OH 12,000 $24,000
Total $26,400
– $4,000 F $2,400 U
Controllable Volume
Variance Variance
– $1,600 F
Total Factory Overhead Cost Variance
Journalize the entries for

recording standards in the
accounts and prepare an
income statement that
includes variances from
standard.
LO 5
Recording and Reporting Variances

 Standard costs may be used as a management tool
to control costs separately from the accounts in
the general ledger.
 However, many companies include both standard
costs and variances, in addition to actual costs, in
their accounts.
LO 5

Western Rider Inc. purchased, on account, the
7,300 square yards of blue denim at $5.50 per
square yard. The standard price is $5.00 per square
yard. The entry to record the purchase and the
unfavorable direct materials price variance is as
follows:
LO 5
$5.50 x 7,300 = $40,150

$3,650 unfavorable direct
$5.00 x 7,300 = $36,500 materials price variance
LO 5

Western Rider Inc. used 7,300 square yards of blue
denim to produce 5,000 pairs of XL jeans. The
standard quantity of denim for the 5,000 jeans
produced is 7,500 square yards. The entry to record
the materials used is as follows:
LO 5
$5.00 x 7,500 = $37,500

– $1,000 favorable direct
$5.00 x 7,300 = $36,500 materials quantity variance
EE 7-5
LO 5

 Two journal entries are usually required for the
purchase and use of direct materials because they
are rarely the same amount.
 Direct labor can be recorded in a single entry
because “what you buy is what you use.”
 The diagram in the next slide was taken from
Exhibit 5 where direct labor variances were
illustrated.
LO 5
Work in Progress 36,000

Direct Labor Rate Variance 3,850
Direct Labor Time Variance 1,350
Wages Payable 38,500
LO 5
Work in Progress 36,000

Direct Labor Rate Variance 3,850
Direct Labor Time Variance 1,350
Wages Payable 38,500
LO 5
EE 7-6
EE 7-6
Describe and
provide examples
of nonfinancial
performance
measures.
LO 6
Nonfinancial Performance Measures

 A nonfinancial performance measure expresses
performance in a measure other than dollars.
LO 6

 Inventory turnover
 Percent on-time delivery
 Elapsed time between a customer order and product
delivery
 Customer preference rankings compared to
competitors
 Response time to a service call
 Time to develop new products
 Employee satisfaction
 Number of customer complaints
LO 6

 Nonfinancial measures can be linked to either the
inputs or outputs of an activity or process.
 A process is a sequence of activities linked
together for performing a particular task.
LO 6

Counter Service Activity of a
Fast-Food Restaurant
Inputs
Number of employees
Outputs
Employee experience
Line wait
Employee training Activity Percent order
Fryer reliability Counter accuracy
Number of new menu service Friendly service
items score
Fountain drinks
available
EE 7-7
Performance Evaluation Using
Budgeting
Variances from Standard Costs
The
The End
End
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
© 2012 Cengage
permitted Learning. All distributed
in a license Rights Reserved.
with aMay notproduct
certain be copied,
or scanned,
service ororotherwise
duplicated,
on ainpassword-protected
whole or in part, except for for
website useclassroom
as use.

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Performance

Performance Evaluation Using

Principles of Managerial Accounting

Reeve Warren Duchac

Describe the types

Reviewing and Revising Standards

Criticisms of Standard Costs

Criticisms of Standard Costs

Budgetary Performance Evaluation

Budgetary Performance Evaluation

Budget Performance Report

Budget Performance Report

Budget Performance Report

Manufacturing Cost Variances

Manufacturing Cost Variances

Manufacturing Cost Variances

Price Difference + Quantity Difference

Manufacturing Cost Variances

Rate Difference + Time Difference

Direct Materials Variances

Direct Materials Variances

Actual costs ($40,150) – Standard costs ($37,500) = $2,650

Direct Materials Price Variance

Direct Materials Price Variance = (Actual Price – Standard Price) x

Direct Materials Quantity Variance

Direct Materials Quantity Variance = (Actual Quantity –

Direct Materials Variance Relationships

 The relationship among the total direct materials

Direct Materials Variance Relationships

Actual cost: Standard cost:

Direct materials Direct materials

Direct Labor Variances

Direct Labor Variances

Total unfavorable direct

Direct Labor Rate Variance

Direct Labor Time Variance

Direct Labor Variance Relationships

Direct labor rate Direct labor time

Factory Overhead Variances

Factory Overhead Flexible Budget

Factory Overhead Flexible Budget

Budgeted Factory Overhead at

Factory Overhead Rate = $6.00 per direct labor hour

Factory Overhead Flexible Budget

Budgeted Variable Overhead

Variable Factory Overhead Rate = $3.60 per direct labor hour

Factory Overhead Flexible Budget

Budgeted Fixed Overhead

Fixed Factory Overhead Rate = $2.40 per direct labor hour

 The budgeted variable factory overhead is the

Fixed Factory Overhead Volume Variance

Fixed Factory Standard Standard Fixed

Fixed Factory Overhead Volume Variance

Fixed Factory Overhead Volume Variance

 An unfavorable volume variance may be due to

Reporting Factory Overhead Variances

 A factory overhead cost variance report is useful

Reporting Factory Overhead Variances

Factory Overhead Account

Applied 5,000 jeans x 0.80

Factory Overhead Account

Total Factory Overhead Actual Factory Applied Factory

Standard Hours for x Total Factory