Acc 206 week 4 assignment (PLEASE DO NOT CHANGE THE PRICE, I ALREADY PAID SOMEONE TO DO THESE AND THEY DID NOT SEND THEM TO ME).

chapter 7 Standard Costs and Variances Learning Objectives • Understand the concepts of standards and standard costs.

• Know how to calculate direct materials price and quantity variances, and understand their implications in assessing material cost and waste.

• Know how to calculate direct labor rate and time variances, and understand their implications in assessing labor cost and utilization.

• Know how to calculate factory overhead volume and controllable variances, and understand their implications in assessing overhead spending and efficiency. istockphoto waL80281_07_c07_169-188.indd 1 9/25/12 1:03 PM 170 Section 7.1 What Are Standards? Chapter Outline 7.1 What Are Standards?Controlling Via Standards Establishing Standards Comparing Actual to Standard 7.2 General Variance Model Variances Relating to Direct Material Impact on the Ledger Variances Relating to Direct Labor Impact on the Ledger Variances Related to Factory Overhead Impact on the Ledger 7.3 Concluding Discussion on Variances I n the previous chapter, you studied budgets and general variances. Recall that a variance is just a departure from the expected outcome. You learned many important concepts, including the idea that budget variances are sometimes explainable by volume fluctua - tions. To the extent that a budget variance is only due to a volume fluctuation,\ it may not be an indication of a lack of cost control or inefficiency. Thus, some variances do not require a response. On the other hand, some unfavorable variances may suggest the n\ eed for swift corrective actions. How is a manager to discern the nature of a budget variance?

One method for sorting out the nature of budget variances is the flexible budget. This concept was also introduced in the previous chapter, and it provides an excellent point of beginning. However, it is only a point of beginning. For example, if a company spent more on direct material than expected, it could be explained by higher than anticipated levels of production, but it could also be due to waste and/or paying more per unit for raw material inputs. Only through a detailed analysis can a manager fully understand the nature of expenditures, and through those understandings begin to look for opportunities for improvement. This is where standards and variance analysis come into play.

7.1 What Are Standards? S tandards are the predetermined expectations about the inputs that will be required to achieve anticipated output. For a manufacturer, inputs generally relate to the factors of production, namely materials, labor, and overhead. Output is usually (but not always) the product or service that is to be delivered to a customer. Standard costs express a measure of what the factors of production should cost.

Standards serve multiple purposes. They are essential to business planning. Standards were implicit in the budget process in the prior chapter. You might recall how Wheat Treat anticipated 10 pounds of direct material for each unit. That scenario represented a straightforward example of a standard that was used in the planning process. Standards were also implicit to cost–volume–profit (CVP) analysis. Recall how CVP techniques were waL80281_07_c07_169-188.indd 2 9/25/12 1:03 PM CHAPTER 7 171 Section 7.1 What Are Standards? used to study many facets of business operations, such as the determinat\ ion of the sales level necessary to achieve profitability. Standards are also very useful in pricing and bill- ing. Have you ever had your car repaired? Look closely at the bill and you will probably see that labor was charged not on actual time or wages but, rather, on a standard amount of time for the designated task. It may have taken the mechanic more or less time to per - form the task, but the work was billed for standard hours and at a standard wage rate.

Standards are also used in control applications, which is the primary focus for this chapter.

Controlling Via Standards Controlling a business requires constant comparison of achieved results to planned or predetermined standards. In this context, standards are the established benchmarks of efficiency and cost incurrence. You have likely been involved with standards in some job you have performed. For example, many people have been employed in fast-\ food restau - rants. You are probably aware that these businesses have very specific expectations about customer wait times, food temperatures, cleanliness guidelines, and so forth. These stan - dards are clearly intended to keep the business operating at peak performance. M\ ost busi - nesses will create their own unique standards. As noted previously, manufacturers tend to focus on the key factors of production in setting standards. Thus, a finished unit can be analyzed from the perspective of its raw material, direct labor, and factory overhead. By the time you complete this chapter, you will be quite familiar with standards and variance calculations related to each. In addition, keep in mind that other nonfinancial standards could relate to product quality, delivery schedule, and so forth; thus, standards apply to both manufacturing and nonmanufacturing environments. Without standards, tasks tend to expand in a costly manner.

Establishing Standards Establishing standards is far more complex than you might think. If you were going to tile a floor, you know that you would likely use more square feet of tile than is the size of the room. The nooks and crannies of the room might require some complex cuts with atten - dant scrap, and the overall dimensions of the room will probably require some wasted end cuts. Then, mistakes are also made. Tiles might be broken, set crooked and have to be chipped up and redone, and so forth. In calculating the quantity of tile to buy, you will probably estimate liberally and then buy a few more for unplanned problems. The last thing you would want to happen is to run out of tiles with the room 95% complete. What if you could not then procure enough additional matching tiles to finish? On the other hand, you certainly would not want to have an enormous quantity of unused tiles, especially if you could not return the unused quantity to the supplier. Calculating the quantity of tiles is very similar to the challenge faced in a manufacturing environment. The managerial accountant would need to study the production environment, taking into consideration waste and spoilage. The problems faced in estimating material also relate to labor. How long should it take to tile the room? No doubt you probably find that your own projects take longer than you expect, especially when unanticipated problems arise. There is also a learning curve. If you were to tile two equally shaped rooms, the second one would prob - ably go much quicker than the first. Again, business standard setters face the same issues.

Managerial accountants may be helpful in performing studies and building\ models that are foundational to establishing standards. For instance, a managerial accountant may be one of the few persons with access to overall information. Overall infor\ mation is needed waL80281_07_c07_169-188.indd 3 9/25/12 1:03 PM CHAPTER 7 172 Section 7.2 General V ariance Model in setting standards because standards are often based on averages; total estimated costs must be divided by total estimated output or activity. This is especially true for overhead where the standard variable overhead is sometimes determined by dividing estimated variable overhead by the estimated activity level. In similar fashion, fixed standard per- unit overhead reflects the total estimated fixed overhead divided by the estimated activity.

Notwithstanding the need to engage the managerial accountants in setting standards, it is also imperative to involve personnel who best understand the operational processes.

These frontline persons will have the best understanding of the specific amounts\ of time and materials that are necessary to achieve desired outcomes. Their realistic assessments are invaluable in providing insight needed to understand what is truly necessary to get a job done and thereby set standards.

Comparing Actual to Standard In the previous chapter, you saw how a budget could be compared to actual results. The mathematical differences were simply referred to as variances. When actual cost is more than planned, an unfavorable variance is produced, and vice versa. This is quite logical. It is the hallmark of variance analysis. The foundation for variance analysis is the setting of standards; without standards, you would have no basis for comparison.

Variance analysis is the examination of the deviations between actual and standard costs.

More important, its objective is to identify areas for improvement. This is an important role for management. Although comparing total actual costs to total standard costs is interesting, it provides little useful information for identifying specific problems that can be corrected. A more penetrating analysis into the detailed variances relating to each fac- tor of production is needed. Developing these analytical tools is the goal for th\ e remainder of this chapter.

7.2 General Variance Model T he point of beginning is to set a general frame of reference and some attendant nomen - clature. Let’s establish the following generalities:

When Actual Cost (AC) . Standard Cost (SC), the result is an Unfavorable Variance (UV) and When SC . AC, the result is a Favorable Variance (FV) Furthermore, AC 5 Actual Quantity (AQ) 3 Actual Price (AP) per unit and SC 5 Standard Quantity (SQ) 3 Standard Price (SP) per unit These general formulations are foundational to the variance analysis techniques that follow. waL80281_07_c07_169-188.indd 4 9/25/12 1:03 PM CHAPTER 7 173 Section 7.2 General V ariance Model Variances Relating to Direct Material There are two primary variances that relate to direct materials. Simply, when a company pays more or less than the standard price per unit, the result is an unfavorable or favor - able price variance. The other type of variance relates to usage. When a company uses more or less than the standard quantity, the result is an unfavorable or favorable usage variance. The combination of both variances results in the total materials variance, reflect - ing a combination of effects related to both pricing and usage. The total variance for direct materials is the overall difference between actual direct material cost and standard direct material cost. Although the total variance is important, the individual variances provide the greatest insight and opportunity for control. Thus, your focus should be on the individual variances.

The materials price variance reveals the difference between the standard price for mate - rials purchased and the amount actually paid for those materials. Thus, the follo\ wing formula applies:

Materials Price Variance 5 (SP 2 AP) 3 AQ In applying the preceding formula, we shall assume that the quantity purchased and the quantity used are identical; additional fine-tuning of the formulas would be necessary i\ f such were not the case.

The materials quantity variance reveals the difference between the standard cost of the standard quantity of materials that should have been used and the standard cost of the actual quantity of materials used. Thus, consider the following form\ ula:

Materials Quantity Variance 5 (SQ 2 AQ) 3 SP In applying either of the preceding formulas, a negative result suggests an unfavorable variance, and vice versa. In other words, negative values produced by these formulations suggest that actual prices/quantities exceed standard prices/quantities. It is important for you to grasp more than just the formulas. It is good for you to also think in terms of favorable and unfavorable conditions by asking the following question: D\ oes this vari- ance create a favorable or unfavorable situation for the company? If there is an unfa - vorable price variance (actual . standard) and an unfavorable labor efficiency variance (actual . standard / budgeted), the total variance would also be unfavorable. In other words, a company does not want to pay more than standard cost for materials (price vari - ance) or use more than the standard requirement for materials.

The preceding formulas are reinforced with an example. Assume that Bamboo Mat Com - pany produces a flat wooden panel that can be used as a serving tray or laptop \ desk. The only raw material that is needed for production—other than glues, sand paper, and stains that are treated as indirect materials—is strips of bamboo that are acquired from a dealer.

In ideal circumstances, each panel requires 20 strips of bamboo that are aligned and glued together. There is normally some spoilage and wasted materials due to imperfections, c\ ut - ting errors, and so forth. Based on a careful analysis of the entire production process, the company believes that the standard amount of material per panel should be 23 strips of bamboo. Bamboo normally costs $0.25 per strip. During the month of February, Bamboo waL80281_07_c07_169-188.indd 5 9/25/12 1:03 PM CHAPTER 7 174 Section 7.2 General Variance Model Mat Company produced 5,000 mats. The company purchased and used 112,000 strips of bamboo, paying an average of $0.26 per strip.

Table 7.1 reveals calculations of total actual and total standard costs for materials.

Table 7.1: Total actual and total standard costs for materials Actual costStandard cost Strips purchased/used 112,000Strips that should have been used (5,000 3 23) 115,000 Per-unit price 3 0.26Per-unit price 3 0.25 Total actual cost $29,120 $28,750 The difference between actual cost of $29,120 and standard cost of $28,750 suggests an unfavorable overall variance of $370 ($28,750 2 $29,120). A casual inspection of the infor-mation suggests that the price per strip was higher than planned ($.026 actual vs.

$0.25 standard), whereas less was used (112,000 strips actual vs. 115,000 strips standard) than anticipated. Thus, logic suggests an unfavorable material price variance and a positive materials quantity variance. Let’s look closely at the actual calculations of each variance: Materials Price Variance 5 (SP 2 AP) 3 AQ 5 ($0.25 2 $0.26) 3 112,000 5 ,$1,120. unfavorable Materials Quantity Variance 5 (SQ 2 AQ) 3 SP 5 (115,000 2 112,000) 3 $0.25 5 $750 favorable Notice that these two specific variances net ( ,$1,120. 1 $750) to the overall $370 unfa - vorable outcome. Although management might be concerned about having overspent by $370, that number provides little information for control. This explains the necessity of splitting the overall variance into its specific subcomponents. The indi\ vidual variances clearly identify that material usage rates are not a problem. The problem was with pric- ing; Bamboo Mat Company paid more than standard cost for each strip of material. This type of analysis allows management to focus on areas for improvement, which should be directed at attempting to improve the purchase price of raw material.

One aspect that should always be considered is the possible interplay between price and quantity variances. It is possible that the higher priced material was o\ f better quality, contributing to less spoilage and waste. This would contribute to offsetting variances.

Whatever the specific cause, management needs to explore variances and take corrective action as necessary. Impact on the Ledger Your understanding of variances should not stop with the basic calculations. It is also important to grasp their impact on the accounting system. Never lose sig\ ht of the fact that waL80281_07_c07_169-188.indd 6 9/25/12 1:03 PM CHAPTER 7 175 Section 7.2 General V ariance Model Bamboo Mat Company spent exactly $29,120 on materials. This is the amoun\ t that must be accounted for. However, under a standard cost system, inventory is recorded at its standard cost, as follows:

2-28-XXRaw Materials Inventory 28,000 Materials Price Variance 1,120 Accounts Payable 29,120 To record purchase of raw materials at standard price This entry records the raw materials at $28,000 (112,000 actual units purchased 3 $0.25 each), with the difference between that amount and the actual price being shown as a debit (unfavorable) to the Materials Price Variance account. If the company had purchased at less than standard price, a credit (favorable variance) would be needed to balance the entry. The clear intention is to record the raw materials inventory at the standard price, regardless of the actual price.

Continuing, as the raw materials are put into process, the Work in Process account is deb - ited for the standard cost of the standard quantity that should be used, regardless of actual use. Differences between standard and actual usage are debited (unfavorable) or credited (favorable) to the Materials Quantity Variance account:

2-28-XX Work in Process Inventory 28,750 Raw Materials Inventory 28,000 Materials Quantity Variance 750 To transfer raw materials to production at standard In the preceding entry, it is important to note that Work in Process is debited for the stan - dard amount of material that was used, calculated at the standard price. Thus, the inven - tory accounts reflect measurements based on standards. The difference between actual and standard is reflected in variance accounts. The Materials Price Variances and Materi- als Quantity Variances are typically disposed of by reporting them as decreases in income (if unfavorable) or increases in income (if favorable). Other methods for closing out vari - ance accounts are possible, and these are usually covered in advanced accounting courses.

Variances Relating to Direct Labor Direct labor variances are strikingly similar to direct materials variances. The overall dif - ference between actual direct labor cost and standard direct labor cost can reflect combi - nations of paying laborers more or less than standard wage rates and/or using more or less direct labor hours than anticipated. Thus, we can separate labor variances \ into rate and time components. waL80281_07_c07_169-188.indd 7 9/25/12 1:03 PM CHAPTER 7 176 Section 7.2 General V ariance Model The labor rate variance reveals the difference between the standard rate and actual rate for the actual labor hours worked. The following formula applies:

Labor Rate Variance 5 (SR 2 AR) 3 AH In this formula, SR is the standard labor rate per hour, AR is the actual labor rate per hour, and AH is the actual hours worked.

The labor time variance compares the standard hours of direct labor that should have been used to the actual hours worked:

Labor Time Variance 5 (SH 2 AH) 3 SR As with the materials variances, negative results for labor variances suggest unfavorable variances, and vice versa. In other words, negative values mean that actual wage rates and/or hours exceeded standard rates/hours.

Let’s continue with our illustration for Bamboo Mat Company. The bamboo strips must be glued together, sanded, and stained. Each mat is anticipated to require 45 minutes of labor by employees who are paid $12 per hour. Recall that 5,000 mats were produced dur - ing February. The standard number of hours of labor required for this level of production is 3,750 hours (5,000 mats 3 3/4 of an hour per mat). At $12 per hour, the standard cost of labor for the month was $45,000 (3,750 hours 3 $12 per hour). Bamboo Mat’s direct labor actually cost $42,350, resulting in an overall favorable variance of $2,650 ($45,000 standard vs. $42,350 actual). What the overall variance does not reveal is the cause of the favorable outcome. Was the result due to lower hourly wage rates, better employee efficiency, or a combination of factors? The rate and time variances will reveal the answers:

Labor Rate Variance 5 (SR 2 AR) 3 AH 5 ($12 2 $11) 3 3,850 5 $3,850 Labor Time Variance 5 (SH 2 AH) 3 SR 5 (3,750 2 3,850) 3 $12 5 ,$1,200.

The rate variance is favorable by $3,850. This reflects that Bamboo Mat Company hired less skilled employees at only $11 per hour rather than $12. This benefit was slightly off- set by an unfavorable time variance. The less skilled laborers took longer to complete the necessary tasks, as revealed by the actual hours of 3,850.

Generalizing, labor variances should be examined as to their root causes. For example, suppose a unionized company hired inexperienced workers during a strike. Although the direct labor rate variance might be favorable (by hiring employees below t\ he union pay scale), it is also highly likely that the labor time variance will \ reflect poorly (assuming inexperienced employees cannot work as fast). Unfavorable labor time variances may also be due to poorly motivated or trained workers, poor materials or faulty \ equipment, poor supervision, and scheduling problems. Management should be held accountable for this outcome because many of the root causes are traced to the degree of supervision, plan - ning, and training that go into production management.

An issue that these variances will not reveal is the quality of workmanship. If a favorable labor variance is the product of working faster and cheaper, quality can suffer. A company waL80281_07_c07_169-188.indd 8 9/25/12 1:03 PM CHAPTER 7 177 Section 7.2 General V ariance Model must clearly assess all aspects of business performance. Nonetheless, th\ e labor variances are vitally important in measuring and monitoring costs associated with di\ rect labor.

Impact on the Ledger Bamboo Mat Company can also record its labor variances in the accounting system. The entry for labor variances is actually simpler than that for inventory. Labor costs flow directly to Work in Process Inventory at standard cost (there is no account equivalent to the Raw Materials Inventory as was needed to track materials). The f\ ollowing entry reflects the standard labor cost, the actual labor obligation, and the differences being charged (when unfavorable) or credited (when favorable) to the labor variance accounts:

2-28-XXWork in Process Inventory 45,000 Labor Time Variance 1,200 Labor Rate Variance 3,850 Wages Payable 42,350 To charge Work in Process for the standard direct labor cost, and record both labor variances As with materials variances, the labor variances typically cause an incr\ ease (favorable) or decrease (unfavorable) in a company’s income during the period in which\ they occur.

Variances Related to Factory Overhead In addition to direct material and direct labor, production processes also require indirect material, indirect labor, and all of the other costs associated with the production facilities.

As you know, this last category is described as factory overhead. Control of factory over - head cost is also important and the subject of additional standards and variance analy - sis. Advanced managerial accounting courses may introduce you to alternative theories about how to calculate and interpret overhead variances. There are two-, three-, and four- variance approaches. The reason for this topic’s complexity relates to the comingling of the application base (e.g., applying overhead based on labor hours) with the overhead cost pool. The following discussion introduces a frame of reference for considering fac - tory overhead variances, but detailed coverage is best deferred to advanced accounting courses, which are likely to devote considerable coverage to this complex topic.

Variable overhead consists of items such as indirect material, indirect labor, and factory supplies. Fixed factory overhead typically relates to expenditures such as rent, deprecia - tion, insurance, and maintenance. Like any other expense category, a company may spend more or less on these items than planned. This is especially true if a business finds that it is producing more or less than budgeted. The goal of the overhead variances is to sort out and explain the reasons for deviations from standard costs.

Let’s continue with our example for Bamboo Mat Company. Prior to the beginning of the month of February, the company prepared a static budget for its overhead expenditures (Table 7.2). waL80281_07_c07_169-188.indd 9 9/25/12 1:03 PM CHAPTER 7 178 Section 7.2 General Variance Model Table 7.2: Static budget for overhead expenditures Budgeted overhead Variable factory overhead$22,500 Fixed factory overhead 9,000 Total factory overhead $31,500 This budget was based on an assumed production level of 4,500 units. These units should require 3,375 hours of direct labor hours, using the previously discussed rate of 3/4 hours per unit. Bamboo Mat Company applies overhead to production based on direct labor hours. This means that the variable overhead application rate is $6.67 per direct labor hour ($22,500 / 3,375), and the fixed overhead application rate is $2.67 per direct labor hour.

The primary purpose of the overhead budget is deriving these overhead application rates.

Because 5,000 units were actually produced, the company would apply the amounts of overhead in Table 7.3 to production.

Table 7.3: Amounts of overhead applied to production Applied overhead for 5,000 units Variable factory overhead (5,000 units 3 3/4 hours per unit 3 $6.67 per hour) $25,012.50 Fixed factory overhead (5,000 units 3 3/4 hours 3 2.67) 10,0 12.50 Total applied factory overhead $35,0 25 The applied overhead is debited to Work in Process. The difference between the amount applied and the amount actually spent constitutes the overall overhead variance. Assume that actual overhead expenses for the month of February were as stated in Table 7.4.

Table 7.4: Actual overhead: February Actual factory overhead Variable factory overhead $24,500 Fixed factory overhead 9,800 Total factory overhead $34,300 The difference between actual factory overhead ($34,300) and applied overhead ($35,025) reflects an overall favorable variance of $725. Of course, a significant factor here is related to the increase in volume. The standard amount of applied fixed overhead is $10,012.50 (3,750 standard hours 3 $2.67 per hour fixed overhead application rate), but the budgeted amount is only $9,000. In other words, added volume results in an overapplication of fixed overhead of $1,012.50 . This is a favorable factory overhead volume variance and is not waL80281_07_c07_169-188.indd 10 9/25/12 1:03 PM CHAPTER 7 179 Section 7.3 Concluding Discussion on Variancesreally controllable; it is the by-product of using a predetermined application rate. In other words, more production is being squeezed from the anticipated fixed overhead expendi-ture.

The difference between the $1,012.50 favorable volume variance and the $7 25 overall favorable variance means the remaining factory overhead controllable variance is $287.50 unfavorable. This $287.50 negative result can also be observed in that the company (1) spent $5 12.50 less on variable overhead (i.e., $24,500 actual vs.

$25,0 12.50 that should have been spent for 5,000 units) and (2) spent $800 more on fixed overhead (i.e., $9,800 actual vs. $9,000 that should have been spent for any level of production). Impact on the Ledger As you suspect, the application of overhead to work in process must be journalized. The following entry reflects an increase in Work in Process for the applied overhead. The vari - ances are debited (unfavorable) and credited (favorable). The actual amount spent on overhead can be captured in several alternative ways. You have not yet been fully exposed to the accumulation and distribution of costs via a unique Factory Overhead account; for now, let’s simply reflect the actual expenditures via a credit to Cash. In Chapter 4, you were exposed to utilization of a Factory Overhead account for the accumulation and dis - tribution of these costs.

2-28-XX Work in Process Inventory 35,0 25 Controllable Overhead Variance 287.50 Overhead Volume Variance 1,012.50 Cash 34,300 To increase Work in Process for the amount of applied overhead, and allocate the difference between that and actual overhead to related variance accounts 7.3 Concluding Discussion on Variances M anagers must constantly monitor operations to ensure business success. This can entail comparing actual performance to budgets and standards. It is not sufficient to just determine that more or less is being spent than was planned. All deviations must be considered in the context in which they occur. Variance analysis is very helpful in pin - pointing the nature of positive and negative outcomes for all costs of production. Only by drilling down on specific variances can management determine what corrective actions are needed. waL80281_07_c07_169-188.indd 11 9/25/12 1:03 PM CHAPTER 7 180 Concept Check Concept Check The five questions that follow relate to several issues raised in the chapter. Test your knowledge of the issues by selecting the best answer. (The correct answers can be found at the end of your text.) 1. The term used for the differ ence between actual costs and the budgeted costs incurred for actual number of outputs is a. static budget variance. b. flexible budget variance.

c.price variance. d. sales volume variance. 2. Flexible budgets assist management in measuring a. the sales volume variance. b. the efficiency of operations at actual levels of activity.

c.the differ ence between standard quantities and expected quantities. d. the differ ence between standard prices and expected prices. 3. Assume that both an unfavorable direct material efficiency variance and a favor - able direct material price variance occur during the same production period.

Choose the best explanation. a. Higher quality direct materials wer e purchased. b. Lower quality direct materials wer e purchased. c.A machine is out of alignment. d. Inexperienced, nonunion direct labor ers were used. 4. Which of the following actions would not help avoid an unfavorable sales\ volume variance?

a. Incentives are pr ovided to the sales force in order to increase quantity of units sold. b. Improved packaging of pr oducts intended to appeal to broader market is imple - mented. c.Unit selling price is increased in or der to increase revenue. d. Advertising on the internet and television is expanded to broader market. 5. Recording direct materials usage in the production process requires a debit to work in process inventory for a. standard quantity for actual pr oduction times standard cost per bushel. b. actual quantity times actual cost per bushel.

c.actual quantity times standard cost per bushel. d. standard quantity for actual pr oduction times actual cost per bushel. waL80281_07_c07_169-188.indd 12 9/25/12 1:03 PM CHAPTER 7 181 Critical Thinking Questions Critical Thinking Questions 1. Give one reason why dir ect material costs may be higher than expected. 2. Define “standards.” 3. Why is it important to sometimes use liberal estimates when establishing\ standards? 4. The foundation for variance analysis is the setting of standards. Explain. 5. Describe a favorable direct material variance. 6. Describe two primary variances that relate to dir ect materials. 7. Explain the potential connection between direct materials price variance and quantity variance. 8. Explain the potential connection between direct labor rate variance and labor time variance. 9. What is the goal of overhead variances? 10. How does management determine proper methods to corr ect negative variances?

factory overhead controllable variance A calculation that explains additional deviations in factory overhead expendi- tures and helps to monitor and control operations.

factory overhead volume variance A calculation that focuses on deviations from standards that are based on producing at levels that are above or below planned levels. labor rate variance A measurement that reveals the difference between the stan- dard rate and actual rate for the actual labor hours worked. labor time variance A measurement that compares the standard hours of direct labor that should have been used to the actual hours worked. materials price variance A measurement that reveals the difference between the standard price for materials purchased and the amount actually paid for those materials. materials quantity variance A measure- ment that reveals the difference between the standard cost of the standard quantity of materials that should have been used and the standard cost of the actual quan- tity of materials used. standards Predetermined expectations about the inputs that will be required to achieve anticipated output. Achievable standards represent realistic goals that are within reach. Ideal standards are meant to represent an ideal goal and hence give no room for mistake. Key Terms waL80281_07_c07_169-188.indd 13 9/25/12 1:03 PM CHAPTER 7 182 Exercises Exercises 1. Cost centers and profit centers Crest Manufacturing produces a single product at its Albany plant. Units are processed through departments A and B and then sent to finished goods. The firm has a maintenance department that performs repair jobs for the manufactur - ing departments.

The maintenance operation has always been evaluated as a cost center. Now with a change in management, a switch to a profit center setup is being considered. Prices charged for repair jobs would be based on the maintenance department’s cost of operations.

a. Discuss the differ ence between a cost center and a profit center. b. Mike Mizer, the head of maintenance, has always operated with a cost minimi - zation philosophy. Will the change to a profit center likely alter the quality of service provided by the maintenance department? Explain your answer. c. What will be the reaction of the manufacturing department changing to a profit center? Consider the probable effect on the number of service req\ uests when structuring your answer. 2. Flexible budgets and performance reports Home Products Inc. uses flexible budgeting for cost control and performance evaluations. A review of the company’s master budget found that management expects to produce 8,000 units each month, resulting in annual expenditures for direct labor and supervisory salaries of $307,200 and $806,400, respectively. Super - visory salaries, a fixed cost, are spread evenly throughout the year. If October ’s production amounted to 7,800 units, and a $2,900 unfavorable direct labor variance was reported, determine a. the actual direct labor cost that appear ed in the October performance report. b. the budgeted amount for supervisory salaries that appeared in the October per - formance report. 3. Variances for direct materials and direct labor Banner Company manufactures flags of various countries. Each flag has a standard of 8 square feet of fabric and 3 hours of direct labor time. Information about recent production activity follows:

Actual cost of fabric: $4.50 per square foot Fabric consumed: 32,080 square feet Standard price per square foot of fabric: $4.25 Standard direct labor rate: $10.00 per hour Actual direct labor rate: $10.20 per hour Actual labor hours worked: 11,940 Actual production completed: 4,000 flags waL80281_07_c07_169-188.indd 14 9/25/12 1:03 PM CHAPTER 7 183 Problems a. Compute the materials price variance and the materials quantity variance\ . b. Compute the labor rate variance and the labor efficiency variance. 4. V ariance analysis: Working backward Auto Lube performs oil changes and other minor maintenance services (e.\ g., tire pressure checks and fluid checks). The company advertises that all services \ are completed in 15 minutes. Eighty cars were serviced on a recent Saturday, resulting in the following labor variances: rate, $18U; efficiency, $64U. If the labor rate stan - dard is $4 per hour, determine the a. standar d hours allowed for Saturday’s work.

b. actual hours worked. c. actual wage rate. 5. Over head variances Nova Manufacturing applies factory overhead to products on the basis of direct labor hours. At the beginning of the current year, the company’s accountant made the following estimates for the forthcoming period:

• Estimated variable overhead: $500,000 • Estimated fixed overhead: $400,000 • Estimated direct labor hours: 40,000 It is now 12 months later. Actual total overhead incurred in the manufacture of 7,900 units amounted to $895,100. Actual labor hours totaled 39,800. Assuming a direct labor standard of 5 hours per finished unit, calculate the following: a. V ariable overhead efficiency variance b. Fixed over head volume variance c. Over head spending variance Problems 1. Basic flexible budgeting Centron Inc. has the following budgeted production costs:

Direct materials $0.40 per unit Direct labor 1.80 per unit Variable factory overhead 2.20 per unit Fixed factory overhead Supervision $24,000 Maintenance 18,000 Other 12,000 waL80281_07_c07_169-188.indd 15 9/25/12 1:03 PM CHAPTER 7 184 Problems The company normally manufactures between 20,000 and 25,000 units each quar- ter. Should output exceed 25,000 units, maintenance and other fixed costs\ are expected to increase by $6,000 and $4,500, respectively.

During the recent quarter ended March 31, Centron produced 25,500 units and incurred the following costs:

Direct materials $ 10,710 Direct labor 47,175 Variable factory overhead 51,940 Fixed factory overhead Supervision 24,500 Maintenance 23,700 Other 16,800 Total production costs $174,825 Instructions a. Pr epare a flexible budget for 20,000, 22,500, and 25,000 units of activity.

b. W as Centron’s experience in the quarter cited better or worse than anticipated\ ? Prepare an appropriate performance report, and explain your answer. c. Explain the benefit of using flexible budgets (as opposed to static\ budgets) in the measurement of performance. 2. Setting standar ds Starr Manufacturing Corporation is considering the implementation of a s\ tandard costing system. The following information pertains to one of the company\ ’s prod - ucts, HD-24:

Direct materials used* $1,020,000 Direct labor - 348,000 Other traceable variable costs Blending costs $ 148,000 Packaging materials 40,700 Miscellaneous 74,000 262,700 Total variable costs $1,630,700 *240,000 gallons at $4.25 per gallon. -58,000 hours at $6.00 per hour. waL80281_07_c07_169-188.indd 16 9/25/12 1:03 PM CHAPTER 7 185 Problems These costs were incurred in the production of 185,000 gallons of HD-24, which were packaged 4 gallons to a case. Starr has been experiencing problems with the quality of materials used and plans to change suppliers in the forthcomi\ ng period.

The price per gallon of direct materials is expected to rise to $4.40. The company anticipates that HD-24 output will total 80% of the direct materials used in produc- tion; the remainder is lost through evaporation.

Management estimates that abnormal production problems in the prior period led to the incurrence of an additional 2,500 labor hours. These problems have been cor - rected and are not expected to recur. Other variable costs are anticipated to remain stable, with the exception of packaging materials. Packaging cost is exp\ ected to increase by $0.04 per gallon.

Instructions a. By analyzing the data pr esented, compute an attainable standard variable cost for a case of HD-24. b. Compar e and contrast ideal and attainable standards. What benefits normally result from the use of attainable standards? c. Discuss several pr oblems that may be encountered in the standard-setting pro - cess by relying too heavily on past experience. 3. V ariance analysis and interpretation Imtex Manufacturing uses a standard costing system. The variable cost standards for product No. 628 follow:

Direct materials: 3.2 pounds , $5 $16.00 Direct labor: 8.5 hours , $8 68.00 Variable overhead: 8.5 hours , $3 25.50 The company has been experiencing rough times of late, with constant complaints from customers about poor product quality. In addition, the production supervisor is very unhappy with the performance reports that he receives to monitor factory operations. A typical report appears as follows: waL80281_07_c07_169-188.indd 17 9/25/12 1:03 PM CHAPTER 7 186 Problems Imtex Manufacturing Performance Report for the Month Ended June 30, 20X3 ActualStandard Variance Direct costs* $XX,XXX$ XX,XXX $ XX,XXX Factory overhead XX,XXX XX,XXX XX,XXX Total $ XX,XXX $ XX,XXX $ XX,XXX *Direct materials + direct labor.

In an effort to improve product quality, the supervisor has campaigned for a change to a better supplier and the hiring of more competent employees. He has recently been given permission to pursue both of these alternatives. Actual data follow: 1) Dir ect materials purchased and consumed amounted to 6,000 pounds at $5.80 per pound. 2) Dir ect labor incurred in the manufacture of 2,000 completed units totaled 15,400 hours at $10.50 per hour. 3) V ariable overhead incurred totaled $47,200. Instructions a. Suggest several ways that Imtex’s performance r eport could be improved to pro - vide better information for the supervisor. b. Pr epare a complete variance analysis for direct materials, direct labor, and vari - able overhead. Note: Compute the overhead spending variance with regard to variable overhead only. c. Does the pr oduction supervisor ’s plan seem to be working? Discuss.

4. Basic flexible budgeting Paragon Inc. normally manufactures between 36,000 and 42,000 units each month.

A static budget based on 36,000 units and actual results for April follows: Budget Actual Direct materials $172,800$175,900 Direct labor 270,000 258,000 Variable factory overhead 115,200 109,000 Supervision 105,000 82,600 Insurance & taxes 60,000 61,500 Depreciation 84,000 88,000 $807,000 $775,000 waL80281_07_c07_169-188.indd 18 9/25/12 1:03 PM CHAPTER 7 187 Problems Conversations with Paragon’s accountant revealed the following information: 1) April’s pr oduction totaled 35,000 units.

2) Supervision, insurance and taxes, and depr eciation are fixed costs.

3) Should pr oduction fall below 36,000 units, supervision costs are expected to be reduced by $20,000 because of temporary layoffs.

Instructions a. Pr epare a flexible budget for 36,000, 39,000, and 42,000 units of activity.

b. Pr epare a performance report for April that can be used to judge Paragon’s suc - cess or failure in meeting budgeted targets. Comment on your findings. c. Explain the flexibility that is associated with a flexible budget. 5. Straightforwar d variance analysis Arrow Enterprises uses a standard costing system. The standard cost sheet for product No. 549 follows:

Direct materials: 4 units , $6.50 $ 26.00 Direct labor: 8 hours , $8.50 68.00 Variable factory overhead: 8 hours , $7.00 56.00 Fixed factory overhead: 8 hours , $2.50 20.00 Total standard cost per unit $170.00 The following information pertains to activity for December: 1) Dir ect materials acquired during the month amounted to 26,350 units at $6.40 per unit. All materials were consumed in operations. 2) Arr ow incurred an average wage rate of $8.75 for 51,400 hours of activity.

3) T otal overhead incurred amounted to $508,400. Budgeted fixed overhead totals $1.8 million and is spread evenly throughout the year. 4) Actual pr oduction amounted to 6,500 completed units. Instructions a. Compute Arrow’s direct material variances.

b. Compute Arrow’s direct labor variances.

c. Compute Arrow’s variances for factory overhead. waL80281_07_c07_169-188.indd 19 9/25/12 1:03 PM CHAPTER 7 waL80281_07_c07_169-188.indd 20 9/25/12 1:03 PM