Performance Evaluation Using Variances from Standard Costs

Objectives
1. Describe the types of standards and how they are established for businesses. 2. Explain and illustrate how standards are used in budgeting. 3. Calculate and interpret direct materials price and quantity variances. 4. Calculate and interpret direct labor rate and time variances.
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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.
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StandardsPerformance 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
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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 = Direct labor: $9.00 per hour x 0.80 hour per pair = Factory overhead: $6.00 per hour x 0.80 hour per pair = Total standard cost per pair

$ 7.50
7.20

4.80 $19.50

Western Rider Inc. Budget Performance Report For the Month Ended June 30, 2006
Standard Cost Cost at Actual Variance Volume (favorable) (5,000 units) Unfavorable

Manufacturing Costs

Actual Costs

Direct materials

$ 40,150

$37,500

$2,650

Direct labor Factory overhead Total mfg. costs

38,500 22,400 $101,050

36,000 24,000 $97,500

2,500 (1,600) $3,550

Direct Materials Cost Variance

Direct Materials Price Variance Direct Materials Qty Variance Direct Labor Rate Variance Direct Labor Time Variance
Variable Factory Overhead Controllable Variance Fixed Factory Overhead Volume Variance
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Total Manufacturing Cost Variance

Direct Labor Cost Variance

Factory Overhead Cost Variance

Direct Materials Price Variance

Actual price per unit Standard price per unit Price variance (unfavorable) $5.50 per sq. yd. 5.00 per sq. yd. $0.50 per sq. yd.

$0.50 times the actual quantity of 7,300 sq. yds. = $3,650 unfavorable

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Direct Materials Quantity Variance

Actual quantity used Standard quantity at actual production Quantity variance (favorable) 7,300 sq. yds. 7,500 (200) sq. yds.

(200) square yards times the standard price of $5.00 = ($1,000) favorable

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Direct Materials Variance Relationships

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

Material Price Variance $3,650 U

Material Quantity Variance ($1,000) F

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Direct Materials Variance Relationships

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

Total Direct Materials Cost Variance $2,650 U

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Direct Labor 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

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Direct Labor 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

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Direct Labor Rate 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

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Direct Labor Time Variance

Actual hours Standard hours at actual production Time variance 3,850 DLH
4,000 DLH (150) DLH

(150) Direct labor hours times the standard rate of $9.00 = ($1,350) favorable

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Direct Labor Variance Relationships

Actual hours x Actual rate 3,850 x $10 = $38,500 Actual hours x Standard rate 3,850 x $9.00 = $34,650
Standard hours x Standard rate 4,000 x $9.00 = $36,000

Direct Labor Rate Variance $3,850 U

Direct Labor Time Variance ($1,350) F

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Direct Labor Variance Relationships

Actual hours x Actual rate 3,850 x $10 = $38,500 Actual hours x Standard rate 3,850 x $9.00 = $34,650
Standard hours x Standard rate 4,000 x $9.00 = $36,000

Total Direct Labor Cost Variance $2,500 U

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Overhead is applied at $6.00 per direct labor hour based on estimated 5,000 total hours.
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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.

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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
Total variable costs Actual variable overhead Variable overhead variancefavorable

80%
$14,400 10,400

100%
$18,000

110%
$19,800

$(4,000)F

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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
Total variable costs Actual variable overhead Variable overhead variancefavorable

80%
$14,400 10,400

100%
$18,000

110%
$19,800

$(4,000)F

Level of activity

Controllable variance based on variable costs

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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 Total fixed costs Fixed cost per DLH

80% 12,000 $3.00

100% 12,000 $2.40

110% 12,000 $2.18

Desired capacity

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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 Total fixed costs Fixed cost per DLH

80% 12,000 $3.00

100% 12,000 $2.40

110% 12,000 $2.18

100% of normal capacity Standard hours at actual production Capacity not used Standard fixed overhead rate at 100% Fixed overhead volume variance

5,000 4,000 1,000 x $2.40 $ 2,400

DLH DLH DLH U

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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 Production) Actual

Variances Favorable Unfavorable

Variable factory overhead costs $14,400 $10,400 Fixed factory overhead costs 12,000 12,000 Total factory overhead costs $26,400 $22,400 Total controllable variances Net controllable variances favorable Volume varianceunfavorable: Capacity not used at the standard rate for fixed factory overhead1,000 x $2.40 Total factory overhead cost variance--favorable

$4,000

$4,000

$4,000

2,400 $1,600
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Fixed Overhead Variances and the Factory Overhead Account

Factory Overhead Actual factory overhead Applied factory $22,400 overhead Balance, June 30 $10,400 + $12,000 $24,000 1,600

4,000 hours x $6.00 per hour

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Fixed Overhead Variances and the Factory Overhead Account

Factory Overhead Actual factory overhead Controllable Variance: Applied factory $22,400 overhead $24,000 1,600

Balance, June 30
$4,000 F $22,400 $26,400

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Fixed Overhead Variances and the Factory Overhead Account

Factory Overhead Actual factory overhead Applied factory $22,400 overhead $24,000 1,600

Balance, June 30
Volume Variance:

$2,400 U
$26,400 $24,000
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Fixed Overhead Variances and the Factory Overhead Account

Total Factory Overhead Variance

Controllable variance Volume variance Total

$4,000 F 2,400 U $1,600 F

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Fixed Overhead Variances and the Factory Overhead Account

Budgeted Factory Overhead for Amount Produced

Controllable variance Fixed factory overhead Total

$14,400 12,000 $26,400

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Recording and Reporting Variances from Standards

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On August 1, Western Rider Inc. purchased, on account, the 7,300 square yards of blue denim at $5.50 per square yard. Recall, the standard price was $5.00.
Aug. 1 Materials (7,300 sq. yds. X $5.00) Direct Materials Price Variance Accounts Payable 36 500 00 3 650 00 40 150 00

$5.50 $5.00

x x

7,300 7,300

$3,650 U = $40,150 Direct = $36,500 materials price variance

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Western Rider Inc. used 7,300 square yards of blue denim to produce 5,000 pairs of XL jeans, compared to the standard of 7,500 square yards. Date the entry August 31.
Aug. 31 Work in Process (7,500 x $5.00) Direct Materials Quantity Variance Materials (7,300 x $5.00) 37 500 00 1 000 00 36 500 00

Standard price x Actual7,300 quantity $5.00 Standard price x Standard quantity $5.00 7,500

$1,000 F = $36,500 Direct = $37,500 Materials quantity variance

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For the month of August, Western Rider Inc. accrued wages of $38,500 (3,850 hours at $10 per hour) in producing 5,000 XL Jeans. The standard rate is $9 per hour and each pair of jeans had a time standard of 0.8 hr.
Aug. 31 Work in Process Direct Labor Rate Variance Direct Labor Time Variance Wages Payable 36 000 00 3 850 00

1 350 00 38 500 00

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

This entry is not shown in the textbook.

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

Sales Cost of goods sold.. Gross profit--at standard.

Less variances from standard cost: Direct materials price.. Direct materials quantity. $1,000 Direct labor rate.. Direct labor time. 1,350 Factory overhead controllable. 4,000 Factory overhead volume Gross profit. Operating expenses. Income before income tax.. $3,650

$140,000 97,500 $ 42,500

Favorable Unfavorable

3,850

2,400

3,550 $38,950 25,725 $13,225

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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

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Nonfinancial Performance Measures (Fast Food Restaurant)

Inputs Employee training Employee experience Number of new menu items Number of employees Fryer reliability Fountain supply availability Outputs Line wait Percent order accuracy Friendly service score

Activity Counter service

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