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Chapter 22

Performance Evaluation
Using Variances from
Standard Costs
Accounting, 21st Edition
Warren Reeve Fess

© Copyright 2004 South-Western, a division


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Objectives
Objectives
1. Describe the types of standards and how
After
After studying
studying
they are established this
this
for businesses.
2. Explain andchapter,
illustrateyou
chapter, you
howshould
should
standards are
be
be able
used in budgeting. able to:
to:
3. Calculate and interpret direct materials price
and quantity variances.
4. Calculate and interpret direct labor rate and
time variances.
Objectives
Objectives
5. Calculate and interpret factory overhead controllable
and volume variances.

6. Journalize the entries for recording


standards in the accounts and prepare
an income statement that includes
variances from standards.
7. Explain how standards may be used for
nonmanufacturing expenses.
8. Explain and provide examples of
nonfinancial performance measures.
Standards—Performance
Standards—Performance Benchmarks
Benchmarks

Setting Standards
Requires joint efforts of accountants, engineers, and
other management personnel

Types of Standards
Theoretical or ideal (world record) standards
Currently attainable standards (normal standards)

Reviewing and Revising Standards


Should be revised when they no longer reflect
operating conditions they intended to measure
Western Rider Inc., a
manufacturer of blue
jeans, uses standard
manufacturing costs
in its budgets.
Western Rider Inc.
Standard Cost per Pair of XL Jeans
Direct materials:
$5.00 per square yard x 1.5 square yards = $ 7.50
Direct labor:
$9.00 per hour x 0.80 hour per pair = 7.20
Factory overhead:
$6.00 per hour x 0.80 hour per pair = 4.80
Total standard cost per pair $19.50
Western Rider Inc.
Budget Performance Report
For the Month Ended June 30, 2006
Standard Cost Cost
at Actual Variance
Actual Volume (favorable)
Manufacturing Costs Costs 5,000
5,000 xx
(5,000 units) Unfavorable
Direct materials $ 40,150 $37,500 $7.50
$7.50 per
$2,650 per
Direct labor 38,500 36,000 pair
2,500pair
Factory overhead 22,400 24,000 (1,600)
Total mfg. costs $101,050 $97,500 $3,550
Direct
DirectMaterials
MaterialsPrice
Price
Direct
Direct Variance
Variance
Materials
Materials
Cost
CostVariance
Variance Direct
DirectMaterials
MaterialsPrice
Price
Variance
Variance

Direct
DirectLabor
LaborRate
Rate
Total
Total Direct
Direct Variance
Variance
Manufacturing
Manufacturing Labor
Labor
Cost
CostVariance
Variance Cost
CostVariance
Variance Direct
DirectLabor
LaborTime
Time
Variance
Variance

Variable
VariableFactory
FactoryOverhead
Overhead
Factory
Factory Controllable
ControllableVariance
Variance
Overhead
Overhead
Cost
CostVariance
Variance Fixed
FixedFactory
FactoryOverhead
Overhead
Volume
VolumeVariance
Variance
Direct
Direct Materials
Materials Price
Price Variance
Variance
Actual price per unit $5.50 per sq. yd.
Standard price per unit 5.00 per sq. yd.
Price variance (unfavorable) $0.50 per sq. yd.
$0.50 times the actual quantity of 7,300 sq. yds.
= $3,650 unfavorable
Direct
Direct Materials
Materials Quantity
Quantity Variance
Variance
Actual quantity used 7,300 sq. yds.
Standard quantity at
actual production 7,500
Quantity variance (favorable) (200) sq. yds.
(200) square yards times the standard price of
$5.00 = ($1,000) favorable
Direct
Direct Materials
Materials
Variance
Variance Relationships
Relationships
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

Material Price Material Quantity


Variance Variance
$3,650 U ($1,000) F
Direct
Direct Materials
Materials
Variance
Variance Relationships
Relationships
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

Total Direct Materials Cost Variance


$2,650 U
Direct
Direct Labor
Labor Variances
Variances
Standard direct labor hours per
of XL jeans 0.80 direct labor hour
Actual units produced x 5,000 pairs of jeans
Standard direct labor hours
budgeted for actual
production 4,000 direct labor hours
Standard rate per DLH x $9.00
Standard direct labor cost
at actual production $36,000
Direct
Direct Labor
Labor Variances
Variances
Actual direct labor hours
used in production 3,850 direct labor hours
Actual rate per direct labor
hour x $10.00
Total actual direct labor cost $ 38,500
Direct
Direct Labor
Labor Rate
Rate Variance
Variance
Actual rate $10.00
Standard rate 9.00
Rate variance (unfavorable) $1.00 per DLH
$1.00 times the actual time of 3,850 hours =
$3,850 unfavorable
Direct
Direct Labor
Labor Time
Time Variance
Variance
Actual hours 3,850 DLH
Standard hours at actual
production 4,000
Time variance (150) DLH

(150) Direct labor hours times the standard rate


of $9.00 = ($1,350) favorable
Direct
Direct Labor
Labor Variance
Variance
Relationships
Relationships
Actual hours x Actual hours x Standard hours x
Actual rate Standard rate Standard rate
3,850 x $10 = 3,850 x $9.00 = 4,000 x $9.00 =
$38,500 $34,650 $36,000

Direct Labor Direct Labor


Rate Variance Time Variance
$3,850 U ($1,350) F
Direct
Direct Labor
Labor Variance
Variance
Relationships
Relationships
Actual hours x Actual hours x Standard hours x
Actual rate Standard rate Standard rate
3,850 x $10 = 3,850 x $9.00 = 4,000 x $9.00 =
$38,500 $34,650 $36,000

Total Direct Labor Cost Variance


$2,500 U
Overhead is applied at $6.00 per direct labor hour
based on estimated 5,000 total hours.
Variances from standard for
factory overhead result from:
1. Actual variable factory
overhead cost greater or less
than budgeted variable
factory overhead for actual
production.
2. Actual production at a level
above or below 100% of
normal capacity.
Western Rider Inc. produced 5,000 pairs
of XL jeans in June. Each pair requires
0.80 standard labor hours for production.
The firm operated at 80% of capacity.
Direct Labor Hours
4,000 5,000 5,500
Percentage of capacity 80% 100% 110%
Total variable costs $14,400 $18,000 $19,800
Actual variable overhead 10,400
Variable overhead
variance—favorable $(4,000) F
Level of activity
Controllable
Controllable variance
variance
based
based on
on variable
variable costs
costs
Western Rider Inc. produced 5,000 pairs
of XL jeans in June. Each pair requires
0.80 standard labor hours for production.
The firm operated at 80% of capacity.
Direct Labor Hours
4,000 5,000 5,500
Percentage of capacity 80% 100% 110%
Total fixed costs 12,000 12,000 12,000
Fixed cost per DLH $3.00 $2.40 $2.18

Desired
Standard hours
capacity
at actual
production
Western Rider Inc. produced 5,000 pairs
of XL jeans in June. Each pair requires
0.80 standard labor hours for production.
The firm operated at 80% of capacity.
Direct Labor Hours
4,000 5,000 5,500
Percentage of capacity 80% 100% 110%
Total fixed costs 12,000 12,000 12,000
Fixed cost per DLH $3.00 $2.40 $2.18
100% of normal capacity 5,000 DLH
Standard hours at actual production 4,000 DLH
Capacity not used 1,000 DLH
Standard fixed overhead rate at 100% x $2.40
Fixed overhead volume variance $ 2,400 U
Western Rider Inc.
Factory Overhead Cost Variance Report
For the Month Ended June 30, 2006
Productive capacity for the month (100% of normal) 5,000 hours
Actual production for the month 4,000 hours
Budget
(at Actual Variances
Production) Actual Favorable
Unfavorable
Variable factory overhead costs $14,400 $10,400 $4,000
Fixed factory overhead costs 12,000 12,000
Total factory overhead costs $26,400 $22,400
Total controllable variances $4,000 $ 0
Net controllable variances—
favorable $4,000
Volume variance—unfavorable:
Capacity not used at the standard rate for fixed
factory overhead—1,000 x $2.40 2,400
Total factory overhead cost variance--favorable $1,600
Fixed
Fixed Overhead
Overhead Variances
Variances and
and the
the
Factory
Factory Overhead
Overhead Account
Account
Factory Overhead
Actual factory Applied factory
overhead $22,400 overhead $24,000
Balance, June 30 1,600
$10,400
$10,400 ++ 4,000
4,000 hours
hours xx
$12,000
$12,000 $6.00
$6.00 per
per hour
hour
Fixed
Fixed Overhead
Overhead Variances
Variances and
and the
the
Factory
Factory Overhead
Overhead Account
Account
Factory Overhead
Actual factory Applied factory
overhead $22,400 overhead $24,000
Balance, June 30 1,600
Controllable
Variance: $4,000 F

$22,400
$22,400 –– $26,400
$26,400
Fixed
Fixed Overhead
Overhead Variances
Variances and
and the
the
Factory
Factory Overhead
Overhead Account
Account
Factory Overhead
Actual factory Applied factory
overhead $22,400 overhead $24,000
Balance, June 30 1,600

Volume
Variance: $2,400 U

$26,400
$26,400 –– $24,000
$24,000
Fixed
Fixed Overhead
Overhead Variances
Variances and
and the
the
Factory
Factory Overhead
Overhead Account
Account

Total Factory Overhead Variance

Controllable variance $4,000 F


Volume variance 2,400 U
Total $1,600 F
Fixed
Fixed Overhead
Overhead Variances
Variances and
and the
the
Factory
Factory Overhead
Overhead Account
Account

Budgeted Factory Overhead for Amount Produced

Controllable variance $14,400


Fixed factory overhead 12,000
Total $26,400
Recording
and
Reporting
Variances
from
Standards
On
On August
August 1,1, Western
Western Rider
Rider Inc.
Inc.
purchased,
purchased, onon account,
account, the
the 7,300
7,300 square
square
yards
yards of
of blue
blue denim
denim at
at $5.50
$5.50 per
per square
square
yard.
yard. Recall,
Recall, the
the standard
standard price
price was
was $5.00.
$5.00.
Aug. 1 Materials (7,300 sq. yds. X $5.00) 36 500 00
Direct Materials Price Variance 3 650 00
Accounts Payable 40 150 00

$3,650 U
$5.50 x 7,300 = $40,150 Direct
$5.00 x 7,300 = $36,500 materials
price
variance
Western
Western Rider
Rider Inc.
Inc. used
used 7,300
7,300 square
square yards
yards
of
of blue
blue denim
denim toto produce
produce 5,0005,000 pairs
pairs of
of XL
XL
jeans,
jeans, compared
compared to to the
the standard
standard of
of 7,500
7,500
square
square yards.
yards. Date
Date thethe entry
entry August
August 31.
31.
Aug. 31 Work in Process (7,500 x $5.00) 37 500 00
Direct Materials Quantity Variance 1 000 00
Materials (7,300 x $5.00) 36 500 00

$1,000 F
Standard
$5.00price x Actual7,300
quantity = $36,500 Direct
Standard price x Standard
$5.00
quantity 7,500 = $37,500 Materials
quantity
variance
For
For the
the month
month ofof August,
August, Western
Western Rider
Rider Inc.
Inc. accrued
accrued
wages
wages ofof $38,500
$38,500 (3,850
(3,850 hours
hours at at $10
$10 per
per hour)
hour) in in
producing
producing 5,000
5,000 XL
XL Jeans.
Jeans. The
The standard
standard rate
rate isis $9
$9 per
per
hour
hour and
and each
each pair
pair of
of jeans
jeans had
had aa time
time standard
standard of of 0.8
0.8 hr.
hr.

Aug. 31 Work in Process 36


000 00
Direct Labor
Direct Rate
Labor Variance
Time Variance 3 850 00 1 350 00
Wages Payable 38 500 00

$10.00
Actual rate x Actual3,850
hours = $38,500
$3,850 U (rate)
Standard
$9.00rate x Actual3,850
hours = $34,650
$1,350 F (time)
Standard
$9.00rate x Standard
4,000quantity = $36,000

This entry is not shown in the textbook.


Western Rider Inc.
Income Statement
For the Month Ended June 30, 2006

Sales…………………………………… $140,000
Cost of goods sold…………………….. 97,500
Gross profit--at standard………………. $ 42,500
Favorable Unfavorable
Less variances from standard cost:
Direct materials price……………….. $3,650
Direct materials quantity……………. $1,000
Direct labor rate…………………….. 3,850
Direct labor time……………………. 1,350
Factory overhead controllable………. 4,000
Factory overhead volume…………… 2,400 3,550
Gross profit……………………………. $38,950
Operating expenses……………………. 25,725
Income before income tax…………….. $13,225
Nonfinancial
Performance Measures
 Inventory turnover
 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
Nonfinancial Performance
Measures (Fast Food
Restaurant)
Inputs
Inputs
Employee
Employeetraining
training Outputs
Outputs
Employee
Employeeexperience
experience Line
Linewait
wait
Number
Numberof ofnew
newmenu
menu Activity
Percent
Percentorder
order
items
items Counter accuracy
accuracy
Number
Numberof ofemployees
employees service Friendly
Friendlyservice
service
Fryer
Fryerreliability
reliability score
score
Fountain
Fountainsupply
supply
availability
availability
Chapter 22

The
The End
End

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