Managerial Accounting Chapter 21 Performance Evaluation Using Variances from Standard Costs

I) Introduction

A) Budgetary control -- comparing actual with planned results 1. Frequency and purpose of reports determined by significance of item and degree of feedback desired.

2. Significant differences should be analyzed to determine causes a. Management by exception -- criteria for identifying items warranting investigation include materiality of an item and controllability of the item

3. Take appropriate corrective action

4. Modify future plans

II) Flexible Budget

A) Master budget is a static budget -- prepared for one level of activity 1. If actual operations are at a different level, actual to budget comparisons might be meaningless.

a. How much of deviation results from difference in activity level versus how much is attributable to management performance?

B) Flexible budget provides budget data for various levels of activity 1. Identify what you will use to measure activity changes (i.e. direct labor hours, machine hours, etc.) Measure chosen should significantly influence the costs being budgeted.

C) Steps in preparing a flexible budget (Factory overhead cost budget) 1. May be prepared after a specific periods activities are completed. 2. Identify variable costs and determine variable costs per unit of activity. 3. Identify the fixed costs and determine budgeted amount for each costs. 4. Prepare the budget for selected increments of activity within the relevant range. a. Total cost function: Total cost = (unit variable cost X activity level) + fixed costs)

D) Flexible budget report provides a mechanism for evaluating a managers performance in production control and cost control. 1. Compares flexible budget amounts for actual level of operations to actual costs (and possibly revenues)

III) Standard Costs

A) Costs that should be incurred to produce a specific product 1. Standards are developed for materials, labor, and overhead. a. Standards should reflect operating conditions--update as necessary

2. Provide a means to assess reasonableness of actual costs a) Differences between actual and standards = variance

3. Ideal standards vs normal standards

B) Material Standards 1. How much should be used?

2. What should it cost?

3. Computation of variances AQ X AP Price Variance AQ X SP Quantity Variance SQ X SP

a) Price variance + Quantity variance = Total variance

4. Price variance is responsibility of purchasing

5. Quantity variance is usually the responsibility of production

C) Labor Standards

1. How long should it take?

2. What should the labor rate be?

3. Computation of variances AH X AR Rate Variance AH X SR Efficiency (Time) Variance SH X SR a) Rate variance + Efficiency (Time) variance = Total labor variance

4. Rate variance might be the responsibility of the personnel administrator or production manager

5. Labor efficiency variance is usually the responsibility of production manager

D) Overhead Standards

1. What overhead costs should be at the projected level of operations for the period. a) Established for both variable and fixed overhead costs.

2. The overhead standards are used in calculating the predetermined overhead rate. a) Note this rate is determined at one specific activity level

3. Overhead is applied to production using the standard overhead rate (i.e. the predetermined overhead rate determined using budgeted activity) multiplied by the standard activity for the actual volume achieved.

4. The difference between the actual and applied overhead may be attributed to:

--- Actual costs not equal expected (budgeted) --- Actual activity level not equal expected (budgeted)

5. Overhead variances

Actual Overhead Controllable variance Budgeted overhead (at actual activity level achieved) Volume variance Applied overhead (standard costs for standard activity level for work done)

a) Controllable variance--is management keeping factory overhead within budget limits?

b) Volume variance--occurs because the activity level actually worked was different from the expected activity level used to compute standard overhead rate. E) Calculation of variances points out potential problem areas. It is the managers responsibility to investigate why.

F) General ledger will normally reflect standard costs for inventories.

1. Variance accounts must therefore be used.

2. Debit balances are unfavorable Credit balances are favorable.

G) Nonfinancial performance measures

1. Performance evaluation is based not only on financial numbers but also balanced with such items as:

On-time delivery Customer complaints Lead times Employee complaints