Chapter 23 Flexible Budgets and Standard Cost Systems

Review Questions 1. What is a variance?

A variance is the difference between an actual amount and the budgeted amount.

2. Explain the difference between a favorable and an unfavorable variance.

A variance is favorable if it increases operating income. For example, if actual revenue is greater than budgeted revenue or if actual expense is less than budgeted expense, then the variance is favorable. If the variance decreases operating income, the variance is unfavorable. For example, if actual revenue is less than budgeted revenue or if actual expense is greater than budgeted expense, the variance is unfavorable.

3. What is a static budget performance report?

A static budget is a budget prepared for only one level of sales volume. A static budget performance report compares actual results to the expected results in the static budget and reports the differences (static budget variances).

4. How do flexible budgets differ from static budgets?

A flexible budget is a budget prepared for various levels of sales volume within a relevant range. A static budget is prepared for only one level of sales volume—the expected number of units sold— and it doesn’t change after it is developed.

5. How is a flexible budget used?

Because a flexible budget is prepared for various levels of sales volume within a relevant range, it provides the basis for preparing the flexible budget performance report and understanding the two components of the overall static budget variance (a static budget is prepared for only one level of sales volume, and a static budget performance report shows only the overall static budget variance).

6. What are the two components of the static budget variance? How are they calculated?

The overall static budget variance is the difference between actual operating income, based on the number of units actually sold, and the expected operating income in the static budget, based on the number of units expected to be sold. The two components of the overall static budget variance are the flexible budget variance and the sales volume variance.

The flexible budget variance is the difference between actual operating income for the number of units actually sold and expected operating income in the flexible budget for the number of units actually sold. The individual flexible budget variances arise when the actual sales price per unit, variable cost per unit, and/or total fixed costs differ from those expected for the number of units actually sold. © 2018 Pearson Education, Inc. 23-1 The sales volume variance is the difference between expected operating income in the flexible budget for the number of units actually sold and expected operating income in the static budget based on the number of units expected to be sold. The sales volume variance and the individual volume variances for sales revenue, variable costs, and contribution margin arise only when the number of units actually sold differs from the number of units expected in the static budget.

7. What is a flexible budget performance report?

A flexible budget performance report compares actual results to the expected results in the flexible budget for the number of units actually sold and compares the expected results in the flexible budget for the number of units actually sold to the expected results in the static budget based on the number of units expected to be sold. By so doing, a flexible budget performance report provides information for managers to understand the underlying causes of variances: (1) flexible budget variances that arise when the actual sales price per unit, variable cost per unit, and/or total fixed costs differ from those expected for the number of units actually sold, and (2) sales volume variances that arise only when the number of units actually sold differs from the number of units expected in the static budget.

8. What is a standard cost system?

A standard cost system is an accounting system that uses standards for product costs—direct materials, direct labor, and manufacturing overhead. (A standard is a price, cost, or quantity that is expected under normal conditions.)

9. Explain the difference between a cost standard and an efficiency standard. Give an example of each.

Each input (direct materials, direct labor, and manufacturing overhead) that goes into making a product has both a cost standard and an efficiency standard. A cost standard is the expected cost of each input and an efficiency standard is the expected quantity of each input to be put into the manufacturing process. For example, the cost standard for direct materials starts with the expected base purchase cost of each unit of materials then factors in expected purchase discounts, freight-in, and receiving costs. The efficiency standard for direct materials is the quantity of direct materials that should be used in the manufacturing process if employees are working efficiently without wasting materials.

10. Give the general formulas for determining cost and efficiency variances.

The cost variance is the difference in costs (actual cost per unit minus standard cost per unit) of an input, multiplied by the actual quantity used of the input. The efficiency variance is the difference in quantities (actual quantity of input used minus standard quantity of input allowed for the actual number of units produced), multiplied by the standard cost per unit of the input.

11. How does the static budget affect cost and efficiency variances?

A static budget is a budget prepared for only one level of sales volume—the number of units expected to be sold—and it doesn’t change after it is developed. The overall static budget variance shown on a static budget performance report is the difference between actual operating income, based on the number of units actually sold, and the expected operating income in the static budget, © 2018 Pearson Education, Inc. 23-2 based on the number of units expected to be sold. The report does not provide information about the two components of the overall static budget variance—the flexible budget variance and the sales volume variance. Cost and efficiency variances are components of flexible budget variances and are based on differences between actual results for the number of units actually sold and expected results for the number of units actually sold. Thus a static budget doesn’t provide the information required to understand cost and efficiency variances.

12. List the direct materials variances, and briefly describe each.

The direct materials variances are the direct materials cost variance and the direct materials efficiency variance.

The direct materials cost variance measures how well the company keeps the actual direct materials cost per unit within standard. A direct materials cost variance is favorable (unfavorable) if the actual direct materials cost per unit is less (greater) than the standard direct materials cost per unit.

The direct materials efficiency variance measures how well the company keeps the actual usage of direct materials within standard. A direct materials efficiency variance is favorable (unfavorable) if the total quantity of direct materials actually used is less (greater) than the total standard allowed to manufacture the actual total quantity of units.

13. List the direct labor variances, and briefly describe each.

The direct labor variances are the direct labor cost variance and the direct labor efficiency variance.

The direct labor cost variance measures how well the company keeps direct labor cost per hour within standard. A direct labor cost variance is favorable (unfavorable) if the actual direct labor cost per hour is less (greater) than the standard direct labor cost per hour.

The direct labor efficiency variance measures how well the company keeps the actual usage of direct labor hours within standard. A direct labor efficiency variance is favorable (unfavorable) if the total number of direct labor hours actually used is less (greater) than the total standard allowed to manufacture the actual total quantity of units.

14. List the variable overhead variances, and briefly describe each.

The variable overhead variances are the variable overhead cost variance and the variable overhead efficiency variance.

The variable overhead cost variance measures how well the company keeps variable overhead cost per unit within standard. A variable overhead cost variance is favorable (unfavorable) if the actual variable cost per unit is less (greater) than the standard variable overhead cost per unit.

The variable overhead efficiency variance measures how well the company keeps actual usage of the allocation base for variable overhead within standard. A variable overhead efficiency variance is favorable (unfavorable) if the total quantity of the allocation base actually used is less (greater) than the total standard allowed to manufacture the actual total quantity of units.

The fixed overhead variances are the fixed overhead cost variance and the fixed overhead volume variance.

The fixed overhead cost variance measures how well the company keeps total fixed overhead cost within standards. A fixed overhead cost variance is favorable (unfavorable) if the actual total fixed overhead cost is less (greater) than the budgeted total fixed overhead cost.

The fixed overhead volume variance is not a cost variance. It is a volume variance and explains why fixed overhead is overallocated or underallocated. A fixed overhead volume variance is favorable (unfavorable) if the number of units actually manufactured is greater (less) than the number of units budgeted. A favorable (unfavorable) fixed overhead volume variance indicates that total fixed overhead cost allocated to units manufactured was greater (less) than the total budgeted fixed overhead cost.

16. How is the fixed overhead volume variance different from the other variances?

The fixed overhead volume variance is not a flexible budget variance (whereas the fixed overhead cost variance and the cost and efficiency variances for variable manufacturing inputs are). As a volume variance, rather than a cost variance, the fixed overhead volume variance shows how allocating fixed costs on a per unit basis causes a difference between budgeted total fixed overhead and allocated total fixed overhead. The allocation results in the overallocation or underallocation of fixed overhead when actual volume is not equal to budgeted volume. A favorable (unfavorable) fixed overhead volume variance indicates that total fixed overhead cost was overallocated (underallocated) to units manufactured; a favorable (unfavorable) fixed overhead volume variance indicates that total fixed overhead cost allocated to units manufactured was greater (less) than the total budgeted fixed overhead cost.

17. What is management by exception?

Management by exception is when managers concentrate on results that are outside the accepted parameters, focusing on the exceptions and investigating variances they believe are significant.

18. List the eight product variances and the manager most likely responsible for each.

Variance Manager Responsible Direct materials cost variance Purchasing Direct materials efficiency variance Production Direct labor cost variance Human Resources Direct labor efficiency variance Production Variable overhead cost variance Production Variable overhead efficiency variance Production Fixed overhead cost variance Production Fixed overhead volume variance Production

Journal entries differ in a standard cost system in the following ways:

• Raw Materials Inventory: Actual quantity at standard cost. • Work-in-Process Inventory, Finished Goods Inventory, and Cost of Goods Sold: Standard quantity of inputs allowed for actual outputs, at standard cost of inputs. • Favorable variances are credited because they increase operating income. • Unfavorable variances are debited because they decrease operating income. • The manufacturing overhead variances will account for the difference between the actual costs debited to Manufacturing Overhead and the standard cost allocated by a credit to Manufacturing Overhead. • A standard cost income statement highlights the variances for management.

20. What is a standard cost income statement?

A standard cost income statement highlights the manufacturing variances for management. It doesn’t alter actual operating income, it simply emphasizes the variances from standard. The statement starts with sales revenue at standard then the favorable (unfavorable) sales revenue variance is added (subtracted) to arrive at sales revenue at actual. Next, cost of goods sold at standard is reported and the eight unfavorable (favorable) manufacturing variances are added (subtracted) to arrive at cost of goods sold at actual. The difference between sales revenue at actual and cost of goods sold at actual is gross profit at actual, from which selling and administrative expenses at actual are subtracted to arrive at operating income at actual.

S23-1 Matching terms Learning Objective 1

Match each term to the correct definition. Terms Definitions a. Flexible budget 1. A summarized budget for several levels of b. Flexible budget volume that separates variable costs from fixed variance costs. c. Sales volume 2. A budget prepared for only one level of sales. variance 3. The difference between an actual amount and the d. Static budget budgeted amount. e. Variance 4. The difference arising because the company actually earned more or less revenue, or incurred more or less cost, than expected for the actual level of output. 5. The difference arising only because the number of units actually sold differs from the static budget units.

SOLUTION

1. a. 2. d. 3. e. 4. b. 5. c.

S23-2 Preparing flexible budgets Learning Objective 1

Moje, Inc. manufactures travel locks. The budgeted selling price is $19 per lock, the variable cost is $9 per lock, and budgeted fixed costs are $13,000 per month. Prepare a flexible budget for output levels of 4,000 locks and 11,000 locks for the month ended April 30, 2018.

SOLUTION

MOJE, INC. Flexible Budget For the Month Ended April 30, 2018

Budget Amounts per Unit Units 4,000 11,000 Sales Revenue $ 19 $ 76,000 $ 209,000 Variable Costs 9 36,000 99,000 Contribution Margin 40,000 110,000 Fixed Costs 13,000 13,000 Operating Income $ 27,000 $ 97,000

S23-3 Calculating flexible budget variances Learning Objective 1

Complete the flexible budget variance analysis by filling in the blanks in the partial flexible budget performance report for 9,000 travel locks for Grant, Inc.

SOLUTION

GRANT, INC. Flexible Budget Performance Report (partial) For the Month Ended April 30, 2018

Actual Flexible Budget Flexible Results Variance Budget Units 9,000 0 9,000 Sales Revenue $ 126,000 $ 18,000 F $ 108,000 Variable Costs 52,300 2,000 U 50,300 Contribution Margin 73,700 16,000 F 57,700 Fixed Costs 16,100 1,200 U 14,900 Operating Income $ 57,600 $ 14,800 F $ 42,800

S23-4 Matching terms Learning Objective 2

Match each term to the correct definition. Terms Definitions a. Benchmarking 1. Measures whether the quantity of materials or b. Efficiency labor used to make the actual number of outputs variance is within the standard allowed for the number of outputs. c. Cost variance 2. Uses standards based on best practice. d. Standard 3. Measures how well the business keeps unit costs of materials and labor inputs within standards. 4. A price, cost, or quantity that is expected under normal conditions.

SOLUTION

1. b. 2. a. 3. c. 4. d.

Setting standards for a product may involve many employees of the company. Identify some of the employees who may be involved in setting the standard costs, and describe what their role might be in setting those standards.

SOLUTION

The purchasing manager provides information about purchase costs, discounts, delivery requirements, and credit policies (for direct materials cost standards).

The human resources manager provides information about wage rates based on experience requirements, payroll taxes, and fringe benefits (for direct labor cost standards).

The production manager and engineers provide information about (1) product specifications, spoilage, and production scheduling (for direct materials efficiency standards) and (2) time requirements for production levels and employee experience needed (for direct labor efficiency standards).

The production manager provides information about the nature and amount of resources needed to support activities, such as moving materials, maintaining equipment, and product inspection (for manufacturing overhead standards).

Martin, Inc. is a manufacturer of lead crystal glasses. The standard direct materials quantity is 1.0 pound per glass at a cost of $0.50 per pound. The actual result for one month’s production of 6,500 glasses was 1.2 pounds per glass, at a cost of $0.30 per pound. Calculate the direct materials cost variance and the direct materials efficiency variance. SOLUTION

Direct Materials Cost Variance = (AC ̶ SC) × AQ = ($0.30 per pound – $0.50 per pound) × 7,800 pounds(a) = $1,560 F

Direct Materials Efficiency Variance = (AQ ̶ SQ) × SC = (7,800 pounds(a) – 6,500 pounds(b)) × $0.50 per pound = $650U

(a) 1.2 pounds per glass × 6,500 glasses = 7,800 actual pounds

(b) 1.0 pound per glass × 6,500 glasses = 6,500 standard pounds

S23-7 Calculating labor variances Learning Objective 3

Martin, Inc. manufactures lead crystal glasses. The standard direct labor time is 0.5 hours per glass, at a cost of $18 per hour. The actual results for one month’s production of 6,500 glasses were 0.2 hours per glass, at a cost of $11 per hour. Calculate the direct labor cost variance and the direct labor efficiency variance. Note: Short Exercises S23-6 and S23-7 must be completed before attempting Short Exercise S23-8.

SOLUTION

Direct Labor Cost Variance = (AC ̶ SC) × AQ = ($11 per DLHr – $18 per DLHr) × 1,300 DLHr(a) = $9,100 F

Direct Labor Efficiency Variance = (AQ ̶ SQ) × SC = (1,300 DLHr(a) – 3,250 DLHr(b)) × $18 per DLHr = $35,100 F

(a) 0.2 DLHr per glass × 6,500 glasses = 1,300 actual DLHr

(b) 0.5 DLHr per glass × 6,500 glasses = 3,250 standard DLHr

S23-8 Interpreting material and labor variances Learning Objective 3

Refer to your results from Short Exercises S23-6 and S23-7. Requirements 1. For each variance, who in Martin’s organization is most likely responsible? 2. Interpret the direct materials and direct labor variances for Martin’s management.

SOLUTION

Requirement 1

Requirement 2

The $1,560 favorable direct materials cost variance calculated in S23-6 indicates that the actual direct materials cost per pound was kept within standard. The $0.30 actual cost per pound was less than the $0.50 standard cost per pound.

The $650 unfavorable direct materials efficiency variance calculated in S23-6 indicates that actual usage of direct materials was not kept within standard. The 7,800 total pounds actually used was greater than the 6,500 total pounds allowed to manufacture 6,500 glasses. © 2018 Pearson Education, Inc. 23-11 S23-8, cont. Requirement 2, cont. The $9,100 favorable direct labor cost variance calculated in S23-7 indicates that the actual direct labor cost per hour was kept within standard. The $11.00 actual cost per direct labor hour was less than the $18.00 standard cost per direct labor hour.

The $35,100 favorable direct labor efficiency variance calculated in S23-7 indicates that actual usage of direct labor hours was kept within standard. The 1,300 total direct labor hours actually used were less than the 3,250 total direct labor hours allowed to manufacture 6,500 glasses.

S23-9 Computing standard overhead allocation rates Learning Objective 4

The following information relates to Morgan, Inc.’s overhead costs for the month: Static budget variable overhead $7,800 Static budget fixed overhead $3,900 Static budget direct labor hours 1,300 hours Static budget number of units 5,200 units Morgan allocates manufacturing overhead to production based on standard direct labor hours. Compute the standard variable overhead allocation rate and the standard fixed overhead allocation rate. Note: Short Exercise S23-9 must be completed before attempting Short Exercise S23-10.

SOLUTION

Standard VOH Budgeted VOH = allocation rate Budgeted allocation base

$7,800 = 1,300 DLHr

= $6.00 per DLHr

Standard FOH Budgeted FOH = allocation rate Budgeted allocation base

$3,900 = 1,300 DLHr

= $3.00 per DLHr

Refer to the Morgan, Inc. data in Short Exercise S23-9. Last month, Morgan reported the following actual results: actual variable overhead, $10,800; actual fixed overhead, $2,770; actual production of 7,000 units at 0.20 direct labor hours per unit. The standard direct labor time is 0.25 direct labor hours per unit (1,300 static direct labor hours / 5,200 static units). Requirements 1. Compute the overhead variances for the month: variable overhead cost variance, variable overhead efficiency variance, fixed overhead cost variance, and fixed overhead volume variance. 2. Explain why the variances are favorable or unfavorable.

SOLUTION

Requirement 1

VOH Cost Variance = Actual VOH − (SC × AQ) = $10,800 − ($6.00 per DLHr(a) × 1,400 DLHr(b)) = $2,400 U

VOH Efficiency Variance = (AQ ̶ SQ) × SC = (1,400 DLHr(b) – 1,750 DLHr(c)) × $6.00 per DLHr(a) = $2,100 F

FOH Cost Variance = Actual FOH ̶ Budgeted FOH = $2,770 ̶ $3,900 = $1,130 F

FOH Volume Variance = Budgeted FOH ̶ Allocated FOH = $3,900 ̶ $5,250(d) = $1,350 F

(a) Calculated in S23-9 (b) 7,000 units produced × 0.2 direct labor hours per unit = 1,400 DLHr (c) 7,000 units produced × 0.25 direct labor hours per unit = 1,750 DLHr (d) $3.00 per DLHr × 1,750 DLHr (c) = $5,250

The $2,400 unfavorable variable overhead cost variance indicates that actual variable overhead cost per direct labor hour was not kept within standard. The $7.71(a) actual cost per direct labor hour was more than the $7.00 standard cost per direct labor hour (the standard variable overhead allocation rate per direct labor hour).

The $2,100 favorable variable overhead efficiency variance indicates that actual usage of direct labor hours was kept within standard. The 1,400 total direct labor hours actually used was less than the 1,750 total direct labor hours allowed to manufacture 7,000 units.

The $1,130 favorable fixed overhead cost variance indicates that actual total fixed cost was kept within budget. The $2,770 actual total fixed overhead cost was less than the $3,900 budgeted total fixed overhead cost.

The $1,350 favorable fixed overhead volume variance is not a cost variance; it is a volume variance and explains why fixed overhead was overallocated. The variance is favorable because the company manufactured more units (7,000) than budgeted (5,200). Therefore, total fixed overhead cost allocated to glasses was $1,350 more than the total budgeted fixed overhead cost ($5,250 total fixed overhead cost was allocated compared with the $3,900 total budgeted fixed overhead cost).

(a) $10,800 / 1,400 DLHr = $7.71 rounded

S23-11 Understanding variance relationships Learning Objective 5

Complete the table below for the missing variances. Total Flexible Budget Product Cost Variance (a) Total Direct Materials Variance Total Direct Labor Variance Total Manufacturing Overhead Variance (b) (c) (d) Direct Direct Materials Materials Direct Direct Labor Total Fixed Cost Efficiency Labor Cost Efficiency Total Variable Overhead Overhead Variance Variance Variance Variance Variance Variance $310 F $165 U $160 U $415 F (e) (f) Variable Variable Fixed Overhead Overhead Overhead Cost Efficiency Cost Variance Variance Variance $525 U $575 F $50 F

SOLUTION

Total Flexible Budget Product Cost Variance $500 F (a) Total Direct Total Direct Total Manufacturing Materials Variance Labor Variance Overhead Variance $145 F (b) $255 F (c) $100 F (d) Direct Direct Direct Direct Total Fixed Materials Materials Labor Labor Total Variable Overhead Cost Efficiency Cost Efficiency Overhead Variance Variance Variance Variance Variance Variance $310 F $165 U $160 U $415 F $50 F (e) $50 F (f) Variable Variable Fixed Overhead Overhead Overhead

Cost Efficiency Cost Variance Variance Variance $525 U $575 F $50 F

Calculations (in the order worked):

(b) $310 F − $165 U = $145 F (c) $160 U − $415 F = $255 F (e) $525 U − $575 F = $50 F (f) $50 F: equal to the fixed overhead cost variance (d) $50 F + $50 F = $100 F (a) $145 F + $255 F + $100 F = $500 F

The following direct materials variance analysis was performed for Moore.

Requirements 1. Record Moore’s direct materials journal entries. Assume purchases were made on account. 2. Explain what management will do with this variance information. SOLUTION Requirement 1

Date Accounts and Explanation Debit Credit Raw Materials Inventory 3,160 Direct Materials Cost Variance 2,370 Accounts Payable 5,530 Purchased direct materials.

Work-in-Process Inventory 2,880 Direct Materials Efficiency Variance 280 Raw Materials Inventory 3,160 Used direct materials.

Requirement 2

It is not enough for Moore’s management to know that a variance occurred. They must know why it occurred. Each of the direct materials variances will be investigated and information will be obtained from the managers responsible for each. (The purchasing manager is responsible for the direct materials cost variance, and the production manager is responsible for the direct materials efficiency variance).

The $2,370 unfavorable direct materials cost variance indicates that the actual direct materials cost per pound was not kept within standard. The $0.70 actual cost per pound was greater than the $0.40 standard cost per pound. © 2018 Pearson Education, Inc. 23-16 S23-12, cont. Requirement 2, cont. The $280 unfavorable direct materials efficiency variance indicates that the actual usage of direct materials was not kept within standard. The 7,900 total pounds actually used was greater than the 7,200 total pounds allowed to manufacture the actual quantity of units.

It should also be noted that there may be trade-offs between the direct materials cost variance and the direct materials efficiency variance. Decisions made by the purchasing manager may affect the direct materials efficiency variance for the production manager. Moore’s purchasing manager may have purchased better quality (higher cost) direct materials, leading to the $2,370 unfavorable direct materials cost variance. Purchasing better quality direct materials could be expected to lead to a favorable direct materials efficiency variance, but this didn’t occur. Instead, the direct materials efficiency variance was unfavorable.

Cautionary remarks: Variances raise questions that can help pinpoint issues. Variances should be used to investigate and make changes, not punish employees. Good managers use variances as a guide for investigation, rather than merely to assign blame, and investigate favorable as well as unfavorable variances.

S23-13 Journalizing labor entries Learning Objective 6

The following direct labor variance analysis was performed for Morris.

Requirements 1. Record Morris’s direct labor journal entry (use Wages Payable). 2. Explain what management will do with this variance information.

SOLUTION

Requirement 1

Date Accounts and Explanation Debit Credit Work-in-Process Inventory 18,900 Direct Labor Efficiency Variance 6,300 Direct Labor Cost Variance 5,400 Wages Payable 19,800 Direct labor costs incurred.

Requirement 2 It is not enough for Morris’s management to know that a variance occurred. They must know why it occurred. Each of the direct labor variances will be investigated and information will be obtained from the managers responsible for each (the human resources manager is responsible for the direct labor cost variance and the production manager is responsible for the direct labor efficiency variance).

The $5,400 favorable direct labor cost variance indicates that the actual direct labor cost per hour was kept within standard. The $11.00 actual cost per direct labor hour was less than the $14.00 standard cost per direct labor hour.

The $6,300 unfavorable direct labor efficiency variance indicates that the actual usage of direct labor hours was not kept within standard. The 1,800 total direct labor hours actually used was greater than the 1,350 total direct labor hours allowed to manufacture the actual quantity of units.

Additionally, there may be trade-offs between the direct labor cost variance and the direct labor efficiency variance. Decisions made by the human resources manager may affect the direct labor efficiency variance for the production manager. Morris’s human resources manager may have hired less skilled (lower paid) direct labor workers, leading to the $5,400 favorable direct labor cost variance. Hiring less skilled direct labor workers would likely have contributed to the $6,300 unfavorable direct labor efficiency variance.

It should be noted that the total direct labor variance was $900 unfavorable (the $5,400 favorable direct labor cost variance minus the $6,300 unfavorable direct labor efficiency variance), indicating that the savings from hiring less skilled direct labor workers did not outweigh the less efficient use of direct labor in production.

Use the following information to prepare a standard cost income statement for Mitchell Company for 2018. Cost of Goods Sold (at standard) $ 366,000 Direct Labor Efficiency Variance $ 19,500 F Sales Revenue (at standard) 570,000 Variable Overhead Efficiency Variance 3,300 U Direct Materials Cost Variance 7,200 U Fixed Overhead Volume Variance 12,500 F Direct Materials Efficiency 2,700 U Selling and Administrative Expenses 71,000 Variance Direct Labor Cost Variance 42,000 U Variable Overhead Cost Variance 1,700 F Fixed Overhead Cost Variance 2,100 F

SOLUTION

MITCHELL COMPANY Standard Cost Income Statement For the Year Ended December 31, 2018

Sales Revenue at standard $ 570,000 Cost of Goods Sold at standard cost $ 366,000 Manufacturing Cost Variances: Direct Materials Cost Variance $ 7,200 Direct Materials Efficiency Variance 2,700 Direct Labor Cost Variance 42,000 Direct Labor Efficiency Variance (19,500) Variable Overhead Cost Variance (1,700) Variable Overhead Efficiency Variance 3,300 Fixed Overhead Cost Variance (2,100) Fixed Overhead Volume Variance (12,500) Total Manufacturing Cost Variances 19,400 Cost of Goods Sold at actual cost 385,400 Gross Profit 184,600 Selling and Administrative Expenses 71,000 Operating Income $ 113,600

E23-15 Preparing a flexible budget

Learning Objective 1

$229,500 Op. Inc. for 55,000 units

Office Plus sells its main product, ergonomic mouse pads, for $13 each. Its variable cost is $5.10 per pad. Fixed costs are $205,000 per month for volumes up to 65,000 pads. Above 65,000 pads, monthly fixed costs are $250,000. Prepare a monthly flexible budget for the product, showing sales revenue, variable costs, fixed costs, and operating income for volume levels of 45,000, 55,000, and 75,000 pads.

SOLUTION

OFFICE PLUS Monthly Flexible Budget

Budget Amounts per Unit Units 45,000 55,000 75,000 Sales Revenue $ 13.00 $ 585,000 $ 715,000 $ 975,000 Variable Costs 5.10 229,500 280,500 382,500 Contribution Margin 355,500 434,500 592,500 Fixed Costs 205,000 205,000 250,000 Operating Income $ 150,500 $ 229,500 $ 342,500

Learning Objective 1

Murphy Company managers received the following incomplete performance report:

Complete the performance report. Identify the employee group that may deserve praise and the group that may be subject to criticism. Give your reasoning.

SOLUTION

MURPHY COMPANY Flexible Budget Performance Report For the Year Ended July 31, 2018

Flexible Sales Actual Budget Flexible Volume Static Results Variance Budget Variance Budget Units 35,000 0 35,000 5,000 F 30,000 Sales Revenue $ 219,000 $ 0 $ 219,000 $ 27,000 F $ 192,000 Variable Expenses 85,000 1,000 U 84,000 13,000 U 71,000 Contribution Margin 134,000 1,000 U 135,000 14,000 F 121,000 Fixed Expenses 105,000 5,000 U 100,000 0 F 100,000 Operating Income $ 29,000 $ 6,000 U $ 35,000 $ 14,000 F $ 21,000

Based on the overall favorable sales volume variance, marketing and sales personnel deserve praise. The number of units actually sold was greater than the number of units expected to be sold. The overall $14,000 favorable sales volume variance is the difference between expected operating income ($35,000) in the flexible budget for the 35,000 units actually sold and expected operating income ($21,000) in the static budget based on 30,000 units expected to be sold. The overall favorable sales volume variance and the individual volume variances for sales revenue ($27,000 favorable), variable expenses ($13,000 unfavorable), and contribution margin ($14,000 favorable) arise only because the company sold 35,000 units rather than the 30,000 units expected in the static budget.

The employee groups that deserve praise or may be subject to criticism for the total variable expenses flexible budget variance and the total fixed expenses flexible budget variance depends on the composition of each these overall variances—production variances versus selling and administrative variances, as well as the individual variances contributing to each of these.

Although the overall variable expenses flexible budget variance is $1,000 unfavorable, this is the net result of variable production flexible budget variances and variable selling and administrative flexible budget variances. Further, a variable production flexible budget variance is the net result of the total direct materials variance, total direct labor variance, and total variable manufacturing overhead variance. Digging even deeper: • The total direct material variance is the net result of the direct materials cost variance (purchasing manager) and direct materials efficiency variance (production manager). • The total direct labor variance is the net result of the direct labor cost variance (human resources manager) and direct labor efficiency variance (production manager). • The total variable manufacturing overhead variance (production manager) is the net result of the variable overhead cost variance and variable overhead efficiency variance.

Similarly, although the overall fixed expenses flexible budget variance is $5,000 unfavorable, this is the net result of the fixed overhead cost variance (production manager) and fixed selling and administrative flexible budget variances (marketing/sales manager and others).

Identification of the magnitude and direction (favorable versus unfavorable) of each of the individual production and selling and administrative variances (both variable and fixed) is prerequisite to determining employees that deserve praise or may be subject to criticism.

Learning Objective 1

Flex. Bud. Var. for Op. Inc. $31,040 F

Top managers of Marshall Industries predicted 2018 sales of 14,800 units of its product at a unit price of $9.50. Actual sales for the year were 14,600 units at $12.00 each. Variable costs were budgeted at $2.00 per unit, and actual variable costs were $2.10 per unit. Actual fixed costs of $48,000 exceeded budgeted fixed costs by $4,000. Prepare Marshall’s flexible budget performance report. What variance contributed most to the year’s favorable results? What caused this variance?

SOLUTION

MARSHALL INDUSTRIES Flexible Budget Performance Report For the Year Ended December 31, 2018 1 2 3 4 5 (1) – (3) (3) – (5) Budget Flexible Sales Amounts Actual Budget Flexible Volume Static per Unit Results Variance Budget Variance Budget Units 14,600 0 14,600 200 U 14,800 Sales Revenue $ 9.50 $ 175,200(a) $ 36,500 F $ 138,700(c) $ 1,900 U $ 140,600(f) Variable Costs 2.00 30,660(b) 1,460 U 29,200(d) 400 F 29,600(g) Contribution 144,540 35,040 F 109,500 1,500 U Margin 111,000 Fixed Costs 48,000 4,000 U 44,000(e) 0 44,000 Operating Income $ 96,540 $ 31,040 F $ 65,500 $ 1,500 U $ 67,000

Flexible Budget Variance Sales Volume Variance $ 31,040 F $ 1,500 U

Static Budget Variance $ 29,540 F

(a) $12.00 per unit × 14,600 units (b) $ 2.10 per unit × 14,600 units (c) $ 9.50 per unit × 14,600 units (d) $ 2.00 per unit × 14,600 units (e) $48,000 − $4,000 (f) $ 9.50 per unit × 14,800 units (g) $ 2.00 per unit × 14,800 units

The $36,500 favorable flexible budget variance for sales revenue contributed the most to the year’s favorable results. The $12.00 actual unit selling price was $2.50 higher than the $9.50 expected unit selling price for the 14,600 units actually sold. This favorable per unit difference was sufficient to more than offset the unfavorable difference in sales volume (the 14,600 units actually sold was 200 less than the 14,800 units expected to be sold, resulting in a $1,900 unfavorable sales volume variance for sales revenue).

E23-18 Defining the benefits of setting cost standards and calculating materials and labor variances

Learning Objectives 2, 3

2. DM Eff. Var. $675 F

Murry, Inc. produced 1,000 units of the company’s product in 2018. The standard quantity of direct materials was three yards of cloth per unit at a standard cost of $1.35 per yard. The accounting records showed that 2,500 yards of cloth were used and the company paid $1.40 per yard. Standard time was two direct labor hours per unit at a standard rate of $10.00 per direct labor hour. Employees worked 1,700 hours and were paid $9.50 per hour. Requirements 1. What are the benefits of setting cost standards? 2. Calculate the direct materials cost variance and the direct materials efficiency variance as well as the direct labor cost and efficiency variances.

SOLUTION

Requirement 1

Benefits of setting cost standards (using a standard costing system) include the following: • Preparing the master budget. • Setting target levels of performance for flexible budgets. • Identifying performance standards. • Setting sales price of products. • Decreasing accounting costs.

Requirement 2

Direct Materials Cost Variance = (AC ̶ SC) × AQ = ($1.40 per yard – $1.35 per yard) × 2,500 yards = $125 U

Direct Materials Efficiency Variance = (AQ ̶ SQ) × SC = (2,500 yards – 3,000 yards(a)) × $1.35 per yard = $675 F

Direct Labor Cost Variance = (AC ̶ SC) × AQ = ($9.50 per DLHr – $10.00 per DLHr) × 1,700 DLHr = $850 F

Direct Labor Efficiency Variance = (AQ ̶ SQ) × SC = (1,700 DLHr – 2,000 DLHr(b)) × $10.00 per DLHr = $3,000 F

(a) 3 yards per unit × 1,000 units = 3,000 standard yards (b) 2 DLHr per unit × 1,000 units = 2,000 standard DLHr

E23-19 Calculating materials and labor variances

Learning Objective 3

DL Eff. Var. $2,400 F

Matthews Fender, which uses a standard cost system, manufactured 20,000 boat fenders during 2018, using 143,000 square feet of extruded vinyl purchased at $1.30 per square foot. Production required 400 direct labor hours that cost $16.00 per hour. The direct materials standard was seven square feet of vinyl per fender, at a standard cost of $1.35 per square foot. The labor standard was 0.028 direct labor hour per fender, at a standard cost of $15.00 per hour. Compute the cost and efficiency variances for direct materials and direct labor. Does the pattern of variances suggest Matthews Fender’s managers have been making trade-offs? Explain.

SOLUTION

Direct Materials Cost Variance = (AC ̶ SC) × AQ = ($1.30 per sq. foot – $1.35 per sq. foot) × 143,000 sq. feet = $7,150 F

Direct Materials Efficiency Variance = (AQ ̶ SQ) × SC = (143,000 sq. feet – 140,000 sq. feet(a)) × $1.35/sq. foot = $4,050 U

Direct Labor Cost Variance = (AC ̶ SC) × AQ = ($16 per DLHr – $15 per DLHr) × 400 DLHr = $400 U

Direct Labor Efficiency Variance = (AQ ̶ SQ) × SC = (400 DLHr – 560 DLHr(b)) × $15 per DLHr = $2,400 F

(a) 7 sq. feet per fender × 20,000 fenders = 140,000 standard sq. feet (b) 0.028 DLHr per fender × 20,000 fenders = 560 standard DLHr

There may be trade-offs between the direct materials cost variance and the direct materials efficiency variance. Decisions made by the purchasing manager may affect the direct materials efficiency variance for the production manager. Matthews Fender’s purchasing manager may have purchased lower quality (less expensive) direct materials, leading to the $7,150 favorable direct materials cost variance (the $1.30 actual direct materials cost per square foot was less than the $1.35 direct materials standard cost per square foot for the 143,000 square feet actually purchased). Lower quality direct materials would likely have contributed to the $4,050 unfavorable direct materials efficiency variance (the 143,000 square feet actually used was greater than the 140,000 square feet allowed for actual production of 20,000 fenders at the $1.35 direct materials standard cost per square foot). However, the total direct materials variance was $3,100 favorable (the $7,150 favorable direct materials cost variance minus the $4,050 unfavorable direct materials efficiency variance), indicating that the savings from lower quality (less expensive) direct materials outweighed the less efficient usage of direct materials in production.

There may be trade-offs between the direct labor cost variance and the direct labor efficiency variance. Decisions made by the human resources manager may affect the direct labor efficiency variance for the production manager. Matthews Fender’s human resources managers may have hired more skilled (higher paid) direct labor workers, leading to the $400 unfavorable direct labor cost variance (the $16 actual direct labor cost per direct labor hour was greater than the $15 direct labor standard cost per direct labor hour). Hiring more skilled direct labor workers would likely have contributed to the $2,400 favorable direct labor efficiency variance (400 direct labor hours actually used was less than the 560 direct labor hours allowed for actual production of 20,000 fenders). However, the total direct labor variance was $2,000 favorable (the $2,400 favorable direct labor efficiency variance minus the $400 unfavorable direct labor cost variance), indicating that the more efficient use of direct labor in production outweighed the higher cost of hiring more skilled direct labor workers.

E23-20 Computing overhead variances

Learning Objective 4

1. FOH Vol. Var. $3,000 U

Mason Fender is a competitor of Matthews Fender from Exercise E23-19. Mason Fender also uses a standard cost system and provides the following information: Static budget variable overhead $ 2,300 Static budget fixed overhead $ 23,000 Static budget direct labor hours 575 hours Static budget number of units 23,000 units Standard direct labor hours 0.025 hours per fender Mason Fender allocates manufacturing overhead to production based on standard direct labor hours. Mason Fender reported the following actual results for 2018: actual number of fenders produced, 20,000; actual variable overhead, $5,350; actual fixed overhead, $26,000; actual direct labor hours, 460. Requirements 1. Compute the overhead variances for the year: variable overhead cost variance, variable overhead efficiency variance, fixed overhead cost variance, and fixed overhead volume variance. 2. Explain why the variances are favorable or unfavorable.

SOLUTION

Requirement 1

Standard VOH Budgeted VOH = allocation rate Budgeted allocation base

$2,300 = 575 DLHr

= $4 per DLHr

Standard FOH Budgeted FOH = allocation rate Budgeted allocation base

$23,000 = 575 DLHr

= $40 per DLHr

VOH Cost Variance = Actual VOH − (SC × AQ) = $5,350 − ($4 per DLHr × 460 DLHr) = $3,510 U

VOH Efficiency Variance = (AQ ̶ SQ) × SC = (460 DLHr – 500 DLHr(a)) × $4 per DLHr = $160 F

FOH Cost Variance = Actual FOH ̶ Budgeted FOH = $26,000 ̶ $23,000 = $3,000 U

(a) 20,000 fenders × 0.025 DLHr per fender = 500 DLHr (b) $40 per DLHr × 500 DLHr = $20,000

Requirement 2

The $3,510 unfavorable variable overhead cost variance indicates that actual variable overhead cost per direct labor hour was not kept within standard. The $11.63(c) actual cost per direct labor hour was greater than the $4.00 standard cost per direct labor hour (the standard variable overhead allocation rate per direct labor hour).

The $160 favorable variable overhead efficiency variance indicates that actual usage of direct labor hours was kept within standard. The 460 total direct labor hours actually used was less than the 500 total direct labor hours allowed to manufacture 20,000 fenders.

The $3,000 unfavorable fixed overhead cost variance indicates that actual total fixed cost was not kept within budget. The $26,000 actual total fixed overhead cost was greater than the $23,000 budgeted total fixed overhead cost.

The $3,000 unfavorable fixed overhead volume variance is not a cost variance. It is a volume variance and explains why fixed overhead was underallocated. The variance is unfavorable because the company manufactured fewer fenders (20,000) than budgeted (23,000). Therefore, total fixed overhead cost allocated to production was $3,000 less than the total budgeted fixed overhead cost ($20,000 total fixed overhead cost was allocated compared with the $23,000 total budgeted fixed overhead cost).

Learning Objective 4

1. VOH Cost Var. $1,600 U

Mills, Inc. is a competitor of Murry, Inc. from Exercise E23-18. Mills also uses a standard cost system and provides the following information: Static budget variable overhead $ 1,200 Static budget fixed overhead $ 1,600 Static budget direct labor hours 800 hours Static budget number of units 400 units Standard direct labor hours 2 hours per unit Mills allocates manufacturing overhead to production based on standard direct labor hours. Mills reported the following actual results for 2018: actual number of units produced, 1,000; actual variable overhead, $4,000; actual fixed overhead, $3,100; actual direct labor hours, 1,600. Requirements 1. Compute the variable overhead cost and efficiency variances and fixed overhead cost and volume variances. 2. Explain why the variances are favorable or unfavorable.

SOLUTION

Requirement 1

Standard VOH Budgeted VOH = allocation rate Budgeted allocation base

$1,200 = 800 DLHr

= $1.50 per DLHr

Standard FOH Budgeted FOH = allocation rate Budgeted allocation base

$1,600 = 800 DLHr

= $2.00 per DLHr

VOH Cost Variance = Actual VOH − (SC × AQ) = $4,000 − ($1.50 per DLHr × 1,600 DLHr) = $1,600 U

VOH Efficiency Variance = (AQ ̶ SQ) × SC = (1,600 DLHr – 2,000 DLHr(a)) × $1.50 per DLHr = $600 F

FOH Cost Variance = Actual FOH ̶ Budgeted FOH = $3,100 ̶ $1,600 = $1,500 U

FOH Volume Variance = Budgeted FOH ̶ Allocated FOH = $1,600 ̶ $4,000(b) = $2,400 F

(a) 1,000 units × 2 DLHr per unit = 2,000 DLHr (b) $2 per DLHr × 2,000 DLHr = $4,000

Requirement 2

The $1,600 unfavorable variable overhead cost variance indicates that actual variable overhead cost per direct labor hour was not kept within standard. The $2.50(a) actual cost per direct labor hour was greater than the $1.50 standard cost per direct labor hour (the standard variable overhead allocation rate per direct labor hour).

The $600 favorable variable overhead efficiency variance indicates that actual usage of direct labor hours was kept within standard. The 1,600 total direct labor hours actually used was less than the 2,000 total direct labor hours allowed to manufacture 1,000 units.

The $1,500 unfavorable fixed overhead cost variance indicates that actual total fixed cost was not kept within budget. The $3,100 actual total fixed overhead cost was greater than the $1,600 budgeted total fixed overhead cost.

The $2,400 favorable fixed overhead volume variance is not a cost variance. It is a volume variance and explains why fixed overhead was overallocated. The variance is favorable because the company manufactured more units (1,000) than budgeted (400). Therefore, total fixed overhead cost allocated to units was $2,400 more than the total budgeted fixed overhead cost ($4,000 total fixed overhead cost was allocated compared with the $1,600 total budgeted fixed overhead cost).

(a) $4,000 / 1,600 DLHr = $2.50 © 2018 Pearson Education, Inc. 23-31 E23-22 Preparing a standard cost income statement Learning Objective 6 GP $270,700 The May 2018 revenue and cost information for McDonald Outfitters, Inc. follows: Sales Revenue (at standard) $ 610,000 Cost of Goods Sold (at standard) 348,000 Direct Materials Cost Variance 1,500 F Direct Materials Efficiency Variance 6,600 F Direct Labor Cost Variance 4,200 U Direct Labor Efficiency Variance 2,700 F Variable Overhead Cost Variance 2,800 U Variable Overhead Efficiency Variance 1,100 U Fixed Overhead Cost Variance 2,300 U Fixed Overhead Volume Variance 8,300 F Prepare a standard cost income statement for management through gross profit. Report all standard cost variances for management’s use. Has management done a good or poor job of controlling costs? Explain.

SOLUTION

MCDONALD OUTFITTERS, INC. Standard Cost Income Statement For the Month Ended May 31, 2018

Sales Revenue at standard $ 610,000 Cost of Goods Sold at standard cost $ 348,000 Manufacturing Cost Variances: Direct Materials Cost Variance $ (1,500) Direct Materials Efficiency Variance (6,600) Direct Labor Cost Variance 4,200 Direct Labor Efficiency Variance (2,700) Variable Overhead Cost Variance 2,800 Variable Overhead Efficiency Variance 1,100 Fixed Overhead Cost Variance 2,300 Fixed Overhead Volume Variance (8,300) Total Manufacturing Cost Variances (8,700) Cost of Goods Sold at actual cost 339,300 Gross Profit $ 270,700

The $1,500 favorable direct materials cost variance indicates that management did a good job keeping actual direct materials cost per unit within standard. The actual cost per unit was less than the standard cost per unit. © 2018 Pearson Education, Inc. 23-32 E23-22, cont.

The $6,600 favorable direct materials efficiency variance indicates that management did a good job keeping actual usage of direct materials within standard. The total quantity of direct materials actually used was less than the total allowed to manufacture the actual total number of units.

The $4,200 unfavorable direct labor cost variance indicates that management did not do a good job keeping actual direct labor cost per hour within standard. The actual cost per direct labor hour was greater than the standard cost per direct labor hour.

The $2,700 favorable direct labor efficiency variance indicates that management did a good job keeping actual usage of direct labor hours within standard. The total number of direct labor hours actually used was less than the total allowed to manufacture the actual total number of units.

The $2,800 unfavorable variable overhead cost variance indicates that management did not do a good job keeping actual variable overhead cost per unit within standard. The actual cost per unit was greater than the standard cost per unit (the standard variable overhead allocation rate per unit).

The $1,100 unfavorable variable overhead efficiency variance indicates that management did not do a good job keeping actual usage of the allocation base for variable overhead within standard. The total quantity of the allocation base actually used was greater than the total allowed to manufacture the actual total number of units.

The $2,300 unfavorable fixed overhead cost variance indicates that management did not do a good job keeping actual total fixed overhead cost within budget. The actual total fixed overhead cost was greater than the budgeted total fixed overhead cost.

The $8,300 favorable fixed overhead volume variance is not a cost variance. It is a volume variance and explains why fixed overhead was overallocated. The variance is favorable because the company manufactured more units than budgeted. Therefore, total fixed overhead cost allocated to units was $8,300 more than the total budgeted fixed overhead cost.

Learning Objective 6

MOH Adj. $1,000 DR

Marsh Company uses a standard cost system and reports the following information for 2018: Standards: 3 yards of cloth per unit at $1.05 per yard 2 direct labor hours per unit at $10.50 per hour Overhead allocated at $5.00 per direct labor hour Actual: 2,600 yards of cloth were purchased at $1.10 per yard Employees worked 1,800 hours and were paid $10.00 per hour Actual variable overhead was $1,700 Actual fixed overhead was $7,300

Marsh Company reported the following variances: Direct materials cost variance $ 130 U Direct materials efficiency variance 420 F Direct labor cost variance 900 F Direct labor efficiency variance 2,100 F Variable overhead cost variance 1,500 U Variable overhead efficiency variance 1,500 F Fixed overhead cost variance 600 U Fixed overhead volume variance 1,600 F

Marsh produced 1,000 units of finished product in 2018. Record the journal entries to record direct materials, direct labor, variable overhead, and fixed overhead, assuming all expenditures were on account and there were no beginning or ending balances in the inventory accounts (all materials purchased were used in production, and all goods produced were sold). Record the journal entries to record the transfer to Finished Goods Inventory and Cost of Goods Sold (omit the journal entry for Sales Revenue). Adjust the Manufacturing Overhead account.

SOLUTION

Date Accounts and Explanation Debit Credit Raw Materials Inventory ($1.05/yard × 2,600 yards) 2,730 Direct Materials Cost Variance 130 Accounts Payable ($1.10/yard × 2,600 yards) 2,860 Purchased direct materials.

Work-in-Process Inventory ($1.05/yard × 3,000 yards) 3,150 Direct Materials Efficiency Variance 420 Raw Materials Inventory ($1.05/yard × 2,600 yards) 2,730 Used direct materials.

Work-in-Process Inventory ($10.50/DLHr × 2,000 DLHr) 21,000 Direct Labor Cost Variance 900 Direct Labor Efficiency Variance 2,100 Wages Payable ($10.00/DLHr × 1,800 DLHr) 18,000 Direct labor costs incurred.

Manufacturing Overhead ($1,700 VOH + $7,300 FOH) 9,000 Various Accounts 9,000 Manufacturing overhead costs incurred.

Work-in-Process Inventory ($5/DLHr × 2,000 DLHr) 10,000 Manufacturing Overhead 10,000 Manufacturing overhead costs allocated.

Finished Goods Inventory ($3,150 + $21,000 + $10,000) 34,150 Work-in-Process Inventory 34,150 Completed goods transferred.

Cost of Goods Sold 34,150 Finished Goods Inventory 34,150 Cost of sales at standard cost.

Manufacturing Overhead 1,000 Variable Overhead Cost Variance 1,500 Fixed Overhead Cost Variance 600 Variable Overhead Efficiency Variance 1,500 Fixed Overhead Volume Variance 1,600 To adjust Manufacturing Overhead.

© 2018 Pearson Education, Inc. 23-35 E23-24 Preparing a standard cost income statement Learning Objective 6 GP $1,097,480 McCarthy Fender, which uses a standard cost system, manufactured 20,000 boat fenders during 2018. The 2018 revenue and cost information for McCarthy follows: Sales Revenue $ 1,300,000 Cost of Goods Sold (at standard) 196,800 Direct materials cost variance 7,150 F Direct materials efficiency variance 5,950 U Direct labor cost variance 400 U Direct labor efficiency variance 530 F Variable overhead cost variance 650 U Variable overhead efficiency variance 360 F Fixed overhead cost variance 2,350 U Fixed overhead volume variance 4,410 U

Assume each fender produced was sold for the standard price of $65, and total selling and administrative costs were $250,000. Prepare a standard cost income statement for 2018 for McCarthy Fender. SOLUTION

MCCARTHY FENDER Standard Cost Income Statement For the Year Ended December 31, 2018

Sales Revenue at standard ($65/fender × 20,000 fenders) $ 1,300,000 Cost of Goods Sold at standard cost $ 196,800 Manufacturing Cost Variances: Direct Materials Cost Variance $ (7,150) Direct Materials Efficiency Variance 5,950 Direct Labor Cost Variance 400 Direct Labor Efficiency Variance (530) Variable Overhead Cost Variance 650 Variable Overhead Efficiency Variance (360) Fixed Overhead Cost Variance 2,350 Fixed Overhead Volume Variance 4,410 Total Manufacturing Cost Variances 5,720 Cost of Goods Sold at actual cost 202,520 Gross Profit 1,097,480 Selling and Administrative Expenses 250,000 Operating Income $ 847,480

P23-25A Preparing a flexible budget performance report Learning Objective 1 3. Static Bud. Var. for Op. Inc. $22,900 F Cell One Technologies manufactures capacitors for cellular base stations and other communications applications. The company’s July 2018 flexible budget shows output levels of 6,000, 7,500, and 9,500 units. The static budget was based on expected sales of 7,500 units.

The company sold 9,500 units during July, and its actual operating income was as follows:

Requirements 1. Prepare a flexible budget performance report for July. 2. What was the effect on Cell One’s operating income of selling 2,000 units more than the static budget level of sales? 3. What is Cell One’s static budget variance for operating income? 4. Explain why the flexible budget performance report provides more useful information to Cell One’s managers than the simple static budget variance. What insights can Cell One’s managers draw from this performance report?

SOLUTION

Requirement 1

CELL ONE TECHNOLOGIES Flexible Budget Performance Report For the Month Ended July 31, 2018 1 2 3 4 5 (1) – (3) (3) – (5) Budget Flexible Sales Amounts Actual Budget Flexible Volume Static per Unit Results Variance Budget Variance Budget Units 9,500 9,500 7,500 Sales Revenue $ 21 $206,500 $ 7,000 F $ 199,500 $ 42,000 F $ 157,500(a) Variable Expenses 10 100,100 5,100 U 95,000 20,000 U 75,000(b) Contribution Margin 106,400 1,900 F 104,500 22,000 F 82,500 Fixed Expenses 56,000 1,000 U 55,000 0 55,000 Operating Income $ 50,400 $ 900 F $ 49,500 $ 22,000 F $ 27,500

Flexible Budget Variance Sales Volume Variance $ 900 F $ 22,000 F

Static Budget Variance $ 22,900 F

(a) $21 per unit × 7,500 units = $157,500 (b) $10 per unit × 7,500 units = $75,000

Requirement 2

Selling 2,000 units more than the static budget level of sales increased Cell One’s operating income by $22,000 (which is the $22,000 favorable sales volume variance calculated in Requirement 1).

Requirement 3

Cell One’s static budget variance for operating income is $22,900 favorable (calculated in Requirement 1).

The static budget is prepared for only one level of sales volume—the 7,500 units expected to be sold— and it doesn’t change after it is developed. The $22,900 favorable static budget variance is the difference between actual operating income ($50,400), based on 9,500 units actually sold, and the expected operating income ($27,500) in the static budget, based on 7,500 units expected to be sold. The flexible budget performance report (Requirement 1) provides more useful information than the simple static budget variance because it separates the $22,900 favorable static budget variance into its components: the $900 favorable flexible budget variance and the $22,000 favorable sales volume variance.

The primary reason for the favorable operating income results is that the 9,500 units actually sold was more than the 7,500 units expected to be sold in the static budget. The overall $22,000 favorable sales volume variance is the difference between the expected operating income ($49,500) in the flexible budget for the 9,500 units actually sold and expected operating income ($27,500) in the static budget based on 7,500 units expected to be sold. The overall favorable sales volume variance and the individual volume variances for sales revenue ($42,000 favorable), variable expenses ($20,000 unfavorable), and contribution margin ($22,000 favorable) arise only because the company sold 9,500 units rather than the 7,500 units expected in the static budget.

The overall $900 favorable flexible budget variance is the difference between actual operating income ($50,400) for the 9,500 units actually sold and expected operating income ($49,500) in the flexible budget for the 9,500 units actually sold. Because the $7,000 favorable flexible budget variance for sales revenue was $900 greater than the sum of the unfavorable flexible budget variances for variable expenses ($5,100) and fixed expenses ($1,000), the overall flexible budget variance (for operating income) was $900 favorable. The individual flexible budget variances arise because actual sales price per unit, variable expense per unit, and fixed expenses were different from those expected for the 9,500 units actually sold. • The $7,000 favorable flexible budget variance for sales revenue was favorable because the $21.74 ($206,500 / 9,500 units, rounded) actual sales price per unit was higher than the $21 per unit budgeted. • The $5,100 unfavorable flexible budget variance for variable expenses was unfavorable because the $10.54 ($100,100 / 9,500 units, rounded) actual variable expense per unit was higher than the $10 per unit budgeted. • The $1,900 favorable flexible budget variance for contribution margin was favorable because the $11.20 ($106,400 / 9,500, rounded) actual contribution margin per unit was higher than the $11 ($21 – $10) per unit budgeted. • The $1,000 unfavorable flexible budget variance for fixed expenses was unfavorable because the $56,000 actual fixed expenses were higher than the $55,000 budgeted.

Learning Objectives 1, 2, 3, 4

2. VOH Eff. Var. $1,368 U

Morton Recliners manufactures leather recliners and uses flexible budgeting and a standard cost system. Morton allocates overhead based on yards of direct materials. The company’s performance report includes the following selected data: Static Budget Actual (1,000 Results (980 recliners) recliners) Sales (1,000 recliners´ $505 each) $ 505,000

(980 recliners´ $480 each) $ 470,400

Variable Manufacturing Costs: Direct Materials (6,000 yds. @ $8.60/yd.) 51,600 (6,143 yds. @ $8.40/yd.) 51,601 Direct Labor (10,000 DLHr @ 92,000 $9.20/DLHr) (9,600 DLHr @ 89,280 $9.30/DLHr) Variable (6,000 yds. @ $5.20/yd.) 31,200 Overhead (6,143 yds. @ $6.60/yd.) 40,544 Fixed Manufacturing Costs: Fixed Overhead 60,600 62,600 Total Cost of Goods Sold 235,400 244,025 Gross Profit $ 269,600 $ 226,375

Requirements 1. Prepare a flexible budget based on the actual number of recliners sold. 2. Compute the cost variance and the efficiency variance for direct materials and for direct labor. For manufacturing overhead, compute the variable overhead cost, variable overhead efficiency, fixed overhead cost, and fixed overhead volume variances. Round to the nearest dollar. 3. Have Morton’s managers done a good job or a poor job controlling materials, labor, and overhead costs? Why? 4. Describe how Morton’s managers can benefit from the standard cost system.

SOLUTION

Requirement 1

MORTON RECLINERS Flexible Budget

Budget Amounts per Unit Actual Units (Recliners) 980 Sales $ 505.00 $ 494,900(d) Variable Manufacturing Costs: Direct Materials 51.60(a) 50,568(e) Direct Labor 92.00(b) 90,160(f) Variable Overhead 31.20(c) 30,576(g) Fixed Manufacturing Costs: Fixed Overhead 60,600 Total Cost of Goods Sold 231,904 Gross Profit $ 262,996

(a) $ 51,600 / 1,000 recliners = $51.60 per recliner (b) $ 92,000 / 1,000 recliners = $ 92.00 per recliner (c) $ 31,200 / 1,000 recliners = $ 31.20 per recliner (d) $505.00 per recliner × 980 recliners = $ 494,900 (e) $ 51.60 per recliner × 980 recliners = 50,568 (f) $ 92.00 per recliner × 980 recliners = 90,160 (g) $ 31.20 per recliner × 980 recliners = 30,576

Requirement 2

Direct Materials Cost Variance = (AC ̶ SC) × AQ = ($8.40 per yard – $8.60 per yard) × 6,143 yards = $1,229 F

Direct Materials Efficiency Variance = (AQ ̶ SQ) × SC = (6,143 yards – 5,880 yards(a)) × $8.60 per yard = $2,262 U

Direct Labor Cost Variance = (AC ̶ SC) × AQ = ($9.30 per DLHr – $9.20 per DLHr) × 9,600 DLHr = $960 U

Direct Labor Efficiency Variance = (AQ ̶ SQ) × SC = (9,600 DLHr – 9,800 DLHr(b)) × $9.20 per DLHr = $1,840 F

VOH Cost Variance = (AC ̶ SC) × AQ = ($6.60 per yard – $5.20 per yard) × 6,143 yards = $8,600 U

VOH Efficiency Variance = (AQ ̶ SQ) × SC = (6,143 yards – 5,880 yards(a)) × $5.20 per yard = $1,368 U

FOH Cost Variance = Actual FOH ̶ Budgeted FOH = $62,600 ̶ $60,600 = $2,000 U

FOH Volume Variance = Budgeted FOH ̶ Allocated FOH = $60,600 ̶ $59,388(c) = $1,212 U

(a) 6,000 yards / 1,000 recliners = 6 yards per recliner Thus: 6 yards per recliner × 980 recliners = 5,880 yards

(b) 10,000 DLHr / 1,000 recliners = 10 DLHr per recliner Thus: 10 DLHr per recliner × 980 recliners = 9,800 DLHr

The $1,229 favorable direct materials cost variance indicates that Morton’s managers did a good job keeping actual direct materials cost per yard within standard. The $8.40 actual cost per yard was less than the $8.60 standard cost per yard.

The $2,262 unfavorable direct materials efficiency variance and $1,368 unfavorable variable overhead efficiency variance indicate that Morton’s managers did not do a good job keeping actual usage of direct materials within standard. The 6,143 total yards actually used was greater than the 5,880 total yards allowed to manufacture 980 recliners.

The $960 unfavorable direct labor cost variance indicates that Morton’s managers did not do a good job keeping actual direct labor cost per hour within standard. The $9.30 actual cost per direct labor hour was greater than the $9.20 standard cost per direct labor hour.

The $1,840 favorable direct labor efficiency variance indicates that Morton’s managers did a good job keeping actual usage of direct labor hours within standard. The 9,600 total direct labor hours actually used was less than the 9,800 total direct labor hours allowed to manufacture 980 recliners.

The $8,600 unfavorable variable overhead cost variance indicates that Morton’s managers did not do a good job keeping actual variable overhead cost per yard within standard. The $6.60 actual cost per yard was greater than the $5.20 standard cost per yard (the standard variable overhead allocation rate per yard).

The $2,000 unfavorable fixed overhead cost variance indicates that Morton’s managers did not do a good job keeping actual total fixed cost within budget. The $62,600 actual total fixed overhead cost was greater than the $60,600 budgeted total fixed overhead cost.

The $1,212 unfavorable fixed overhead volume variance is not a cost variance. It is a volume variance and explains why fixed overhead was underallocated. The variance is unfavorable because the company manufactured fewer recliners (980) than budgeted (1,000). Therefore, total fixed overhead cost allocated to recliners was $1,212 less than the total budgeted fixed overhead cost ($59,388 total fixed overhead cost was allocated compared with the $60,600 total budgeted fixed overhead cost).

Morton’s managers can benefit from the standard costing system in the following ways: • Preparing the master budget. • Setting target levels of performance for flexible budgets. • Identifying performance standards. • Setting sales price of products. • Decreasing accounting costs.

P23-27A Computing standard cost variances and reporting to management

Learning Objectives 3, 4, 5

1. DM Eff. Var. $150 F 2. Hear Smart manufactures headphone cases. During September 2018, the company produced and sold 105,000 cases and recorded the following cost data: Standard Cost Information Quantity Cost Direct Materials 2 parts $ 0.15 per part Direct Labor 0.02 hours 8.00 per hour Variable Manufacturing Overhead 0.02 hours 10.00 per hour Fixed Manufacturing Overhead ($28,500 for static budget volume of 95,000 units and 1,900 hours, or $15 per hour)

Actual Cost Information Direct Materials (209,000 parts @ $0.20 per part) $ 41,800 Direct Labor (1,600 hours @ $8.15 per hour) 13,040 Variable Manufacturing Overhead 9,000 Fixed Manufacturing Overhead 26,000

Requirements 1. Compute the cost and efficiency variances for direct materials and direct labor. 2. For manufacturing overhead, compute the variable overhead cost and efficiency variances and the fixed overhead cost and volume variances. 3. Hear Smart’s management used better quality materials during September. Discuss the trade-off between the two direct material variances.

SOLUTION

Requirement 1

Direct Materials Cost Variance = (AC ̶ SC) × AQ = ($0.20 per part – $0.15 per part) × 209,000 parts = $10,450 U

Direct Materials Efficiency Variance = (AQ ̶ SQ) × SC = (209,000 parts – 210,000 parts(a)) × $0.15 per part = $150 F

Direct Labor Cost Variance = (AC ̶ SC) × AQ = ($8.15 per DLHr – $8.00 per DLHr) × 1,600 DLHr = $240 U

Direct Labor Efficiency Variance = (AQ ̶ SQ) × SC = (1,600 DLHr – 2,100 DLHr(b)) × $8.00 per DLHr = $4,000 F

(a) 2 parts per case × 105,000 cases = 210,000 parts (b) 0.02 DLHr per case × 105,000 cases = 2,100 DLHr

VOH Cost Variance = Actual VOH − (SC × AQ) = $9,000 − ($10 per DLHr × 1,600 DLHr) = $7,000 F

VOH Efficiency Variance = (AQ ̶ SQ) × SC = (1,600 DLHr – 2,100 DLHr(a)) × $10 per DLHr = $5,000 F

FOH Cost Variance = Actual FOH ̶ Budgeted FOH = $26,000 ̶ $28,500 = $2,500 F

FOH Volume Variance = Budgeted FOH ̶ Allocated FOH = $28,500 ̶ $31,500(b) = $3,000 F

(a) Calculated in Requirement 1 (b) $15 per DLHr × 2,100 DLHr = $31,500

Requirement 3

There may be trade-offs between the direct materials cost variance and the direct materials efficiency variance. Decisions made by the purchasing manager may affect the direct materials efficiency variance for the production manager. Perhaps Hear Smart used better quality direct materials, indicated by the fact that the $0.20 actual direct materials cost per part was greater than the $0.15 direct materials standard cost per part. Therefore, the direct materials cost variance was $10,450 unfavorable for the 209,000 parts actually purchased. If so, then the better quality direct materials likely contributed to the $150 favorable direct materials efficiency variance (209,000 parts actually used was less than the 210,000 parts allowed for actual production of 105,000 cases). However, the total direct materials variance was $10,300 unfavorable (the $10,450 unfavorable direct materials cost variance minus the $150 favorable direct materials efficiency variance), indicating that the more efficient usage of direct materials did not outweigh the higher cost of the direct materials purchased. However, the higher quality components may result in higher quality and durable final products which may lead to fewer returns and warranty claims due to product failures and higher customer satisfaction.

Learning Objectives 3, 4, 5, 6

3. VOH Cost Var. $985 F

Moss manufactures coffee mugs that it sells to other companies for customizing with their own logos. Moss prepares flexible budgets and uses a standard cost system to control manufacturing costs. The standard unit cost of a coffee mug is based on static budget volume of 59,800 coffee mugs per month: Direct Materials (0.2 lbs. @ $0.25 per lb.) $ 0.05 Direct Labor (3 minutes @ $0.11 per minute) 0.33 Manufacturing Overhead: Variable (3 minutes @ $0.06 per minute) $ 0.18 Fixed (3 minutes @ $0.13 per minute) 0.39 0.57 Total Cost per Coffee Mug $ 0.95

Actual cost and production information for July 2018 follows: a. There were no beginning or ending inventory balances. All expenditures were on account. b. Actual production and sales were 62,500 coffee mugs. c. Actual direct materials usage was 11,000 lbs. at an actual cost of $0.17 per lb. d. Actual direct labor usage was 197,000 minutes at a total cost of $25,610. e.. Actual overhead cost was $10,835 variable and $29,765 fixed. f. Selling and administrative costs were $95,000. Requirements 1. Compute the cost and efficiency variances for direct materials and direct labor. 2. Journalize the purchase and usage of direct materials and the assignment of direct labor, including the related variances. 3. For manufacturing overhead, compute the variable overhead cost and efficiency variances and the fixed overhead cost and volume variances. 4. Journalize the actual manufacturing overhead and the allocated manufacturing overhead. Journalize the movement of all production costs from Work-in-Process Inventory. Journalize the adjusting of the Manufacturing Overhead account. 5. Moss intentionally hired more highly skilled workers during July. How did this decision affect the cost variances? Overall, was the decision wise?

Direct Materials Cost Variance = (AC ̶ SC) × AQ = ($0.17 per lb. – $0.25 per lb.) × 11,000 lbs. = $880 F

Direct Materials Efficiency Variance = (AQ ̶ SQ) × SC = (11,000 lbs. – 12,500 lbs.(a)) × $0.25 per lb. = $375 F

Direct Labor Cost Variance = (AC ̶ SC) × AQ = ($0.13 per min.(b) – $0.11 per min.) × 197,000 min. = $3,940 U

Direct Labor Efficiency Variance = (AQ ̶ SQ) × SC = (197,000 min. – 187,500 min.(c)) × $0.11 per min. = $1,045 U

(a) 0.2 lbs. per mug × 62,500 mugs = 12,500 lbs. (b) $25,610 total cost / 197,000 minutes = $0.13 cost per minute (c) 3 minutes per mug × 62,500 mugs = 187,500 minutes

Requirement 2

Date Accounts and Explanation Debit Credit Raw Materials Inventory ($0.25/lb. × 11,000 lbs.) 2,750 Direct Materials Cost Variance (from Req. 1) 880 Accounts Payable ($0.17/lb. × 11,000 lbs.) 1,870 Purchased direct materials.

Work-in-Process Inventory ($0.25/lb. × 12,500 lbs.) 3,125 Direct Materials Efficiency Variance (from Req. 1) 375 Raw Materials Inventory ($0.25/lb. × 11,000 lbs.) 2,750 Used direct materials.

Work-in-Process Inventory ($0.11/min. × 187,500 min.) 20,625 Direct Labor Cost Variance (from Req. 1) 3,940 Direct Labor Efficiency Variance (from Req. 1) 1,045 Wages Payable ($0.13/min. × 197,000 min.) 25,610 Direct labor costs incurred.

VOH Cost Variance = Actual VOH − (SC × AQ) = $10,835 − ($0.06 per min. × 197,000 min.) = $985 F

VOH Efficiency Variance = (AQ ̶ SQ) × SC = (197,000 min. – 187,500 min.(a)) × $0.06 per min. = $570 U

FOH Cost Variance = Actual FOH ̶ Budgeted FOH = $29,765 ̶ $23,322(b) = $6,443 U

FOH Volume Variance = Budgeted FOH ̶ Allocated FOH = $23,322(b) ̶ $24,375(c) = $1,053 F

(a) Calculated in Requirement 1 (b) $0.39 per mug × 59,800 mugs = $23,322 (c) $0.13 per min. × 3 min. per mug × 62,500 mugs = $24,375

Requirement 4

Date Accounts and Explanation Debit Credit Manufacturing Overhead ($10,835 VOH + $29,765 FOH) 40,600 Various Accounts 40,600 Manufacturing overhead costs incurred.

Work-in-Process Inventory ($0.57/mug × 62,500 mugs) 35,625 Manufacturing Overhead 35,625 Manufacturing overhead costs allocated.

Finished Goods Inventory ($3,125 + $20,625 + $35,625) 59,375 Work-in-Process Inventory 59,375 Completed goods transferred.

Variable Overhead Efficiency Variance (from Req. 3) 570 Fixed Overhead Cost Variance (from Req. 3) 6,443 Variable Overhead Cost Variance (from Req. 3) 985 Fixed Overhead Volume Variance (from Req. 3) 1,053 Manufacturing Overhead 4,975 To adjust Manufacturing Overhead.

P23-28A, cont. Requirement 5

Because Moss hired more skilled workers, the $0.13 actual direct labor cost per minute was greater than the $0.11 direct labor standard cost per minute. Therefore, the direct labor cost variance was $3,940 unfavorable for the 62,500 mugs actually produced. Hiring more skilled direct labor workers could be expected to lead to a favorable direct labor efficiency variance, but this didn’t occur. Instead, the direct labor efficiency variance was $1,045 unfavorable (197,000 minutes of direct labor time actually used was more than the 187,500 direct labor minutes allowed for actual production of 62,500 mugs). Combining the two direct labor variances, the total direct labor variance was $4,985 unfavorable (the $3,940 unfavorable direct labor cost variance plus the $1,045 unfavorable direct labor efficiency variance). Overall, Moss’s decision to hire more skilled direct labor workers was not wise.

Note: Problem P23-28A must be completed before attempting Problem P23-29A.

P23-29A Preparing a standard cost income statement

Learning Objective 6

COGS at actual $68,080

Review your results from Problem P23-28A. Moss’s standard and actual sales price per mug is $3. Prepare the standard cost income statement for July 2018.

SOLUTION

MOSS Standard Cost Income Statement For the Month Ended July 31, 2018

Sales Revenue at standard ($3/mug × 62,500 mugs) $ 187,500 Cost of Goods Sold at standard cost (from P23-28A) $ 59,375 Manufacturing Cost Variances (from P23-28A): Direct Materials Cost Variance $ (880) Direct Materials Efficiency Variance (375) Direct Labor Cost Variance 3,940 Direct Labor Efficiency Variance 1,045 Variable Overhead Cost Variance (985) Variable Overhead Efficiency Variance 570 Fixed Overhead Cost Variance 6,443 Fixed Overhead Volume Variance (1,053) Total Manufacturing Cost Variances 8,705 Cost of Goods Sold at actual cost 68,080 Gross Profit 119,420 Selling and Administrative Expenses 95,000 Operating Income / (Loss) $ 24,420

P23-30B Preparing a flexible budget performance report

Learning Objective 1

3. Static Bud. Var. for Op. Inc. $22,900 F

Cell Plus Technologies manufactures capacitors for cellular base stations and other communication applications. The company’s July 2018 flexible budget shows output levels of 8,500, 10,000, and 12,000 units. The static budget was based on expected sales of 10,000 units.

The company sold 12,000 units during July, and its actual operating income was as follows:

Requirements 1. Prepare a flexible budget performance report for July 2018. 2. What was the effect on Cell Plus’s operating income of selling 2,000 units more than the static budget level of sales? 3. What is Cell Plus’s static budget variance for operating income? 4. Explain why the flexible budget performance report provides more useful information to Cell Plus’s managers than the simple static budget variance. What insights can Cell Plus’s managers draw from this performance report? © 2018 Pearson Education, Inc. 23-51 P23-30B, cont.

SOLUTION

Requirement 1

CELL PLUS TECHNOLOGIES Flexible Budget Performance Report For the Month Ended July 31, 2018 1 2 3 4 5 (1) – (3) (3) – (5) Budget Flexible Sales Amounts Actual Budget Flexible Volume Static per Unit Results Variance Budget Variance Budget Units 12,000 0 12,000 2,000 F 10,000 Sales Revenue $ 24 $ 295,000 $ 7,000 F $ 288,000 $ 48,000 F $ 240,000(a) Variable Expenses 13 161,100 5,100 U 156,000 26,000 U 130,000(b) Contribution Margin 133,900 1,900 F 132,000 22,000 F 110,000 Fixed Expenses 58,000 1,000 U 57,000 0 57,000 Operating Income $ 75,900 $ 900 F $ 75,000 $ 22,000 F $ 53,000

Flexible Budget Variance Sales Volume Variance $ 900 F $ 22,000 F

Static Budget Variance $ 22,900 F

(a) $24 per unit × 10,000 units = $240,000 (b) $13 per unit × 10,000 units = $130,000

Requirement 2

Selling 2,000 units more than the static budget level of sales increased Cell Plus’s operating income by $22,000 (which is the $22,000 favorable sales volume variance calculated in Requirement 1).

Requirement 3

Cell Plus’s static budget variance for operating income is $22,900 favorable (calculated in Requirement 1).

The static budget is prepared for only one level of sales volume—the 10,000 units expected to be sold— and it doesn’t change after it is developed. The $22,900 favorable static budget variance is the difference between actual operating income ($75,900), based on 12,000 units actually sold, and the expected operating income ($53,000) in the static budget, based on 10,000 units expected to be sold. It is not enough for managers to know that a variance occurred. They must know why it occurred. The flexible budget performance report (Requirement 1) provides more useful information than the simple static budget variance because it separates the $22,900 favorable static budget variance into its components: the $900 favorable flexible budget variance and the $22,000 favorable sales volume variance.

The primary reason for the favorable operating income results is that the 12,000 units actually sold was more than the 10,000 units expected to be sold in the static budget. The overall $22,000 favorable sales volume variance is the difference between the expected operating income ($75,000) in the flexible budget for the 12,000 units actually sold and expected operating income ($53,000) in the static budget based on 10,000 units expected to be sold. The overall favorable sales volume variance and the individual volume variances for sales revenue ($48,000 favorable), variable expenses ($26,000 unfavorable), and contribution margin ($22,000 favorable) arise only because the company sold 12,000 units rather than the 10,000 units expected in the static budget.

The overall $900 favorable flexible budget variance is the difference between actual operating income ($75,900) for the 12,000 units actually sold and expected operating income ($75,000) in the flexible budget for the 12,000 units actually sold. Because the $7,000 favorable flexible budget variance for sales revenue was $900 greater than the sum of the unfavorable flexible budget variances for variable expenses ($5,100) and fixed expenses ($1,000), the overall flexible budget variance (for operating income) was $900 favorable. The individual flexible budget variances arise because actual sales price per unit, variable expense per unit, and fixed expenses were different from those expected for the 12,000 units actually sold. • The $7,000 favorable flexible budget variance for sales revenue was favorable because the $24.58 ($295,000 / 12,000 units, rounded) actual sales price per unit was higher than the $24 per unit budgeted. • The $5,100 unfavorable flexible budget variance for variable expenses was unfavorable because the $13.43 ($161,100 / 12,000 units, rounded) actual variable expense per unit was higher than the $13 per unit budgeted. • The $1,900 favorable flexible budget variance for contribution margin was favorable because the $11.16 ($133,900 / 12,000 units, rounded) actual contribution margin per unit was higher than the $11 ($24 – $13) per unit budgeted. • The $1,000 unfavorable flexible budget variance for fixed expenses was unfavorable because the $58,000 actual fixed expenses were higher than the $57,000 budgeted.

Learning Objectives 1, 2, 3, 4

2. VOH Eff. Var. $1,377 U

McKnight Recliners manufactures leather recliners and uses flexible budgeting and a standard cost system. McKnight allocates overhead based on yards of direct materials. The company’s performance report includes the following selected data: Static Budget Actual (1,025 Results (1,005 recliners) recliners) Sales (1,025 recliners´ $500 each) $ 512,500

(1,005recliners´ $495each) $ 497,475

Variable Manufacturing Costs: Direct Materials (6,150 yds. @ $8.50/yard) 52,275 (6,300 yds. @ $8.30/yard) 52,290 Direct Labor (10,250 DLHr @ 94,300 $9.20/DLHr) (9,850 DLHr @ 92,590 $9.40/DLHr) Variable Overhead (6,150 yds. @ $5.10/yard) 31,365 (6,300 yds. @ $6.50/yard) 40,950 Fixed Manufacturing Costs: Fixed Overhead 62,730 64,730 Total Cost of Goods Sold 240,670 250,560 Gross Profit $ 271,830 $ 246,915

Requirements 1. Prepare a flexible budget based on the actual number of recliners sold. 2. Compute the cost variance and the efficiency variance for direct materials and for direct labor. For manufacturing overhead, compute the variable overhead cost, variable overhead efficiency, fixed overhead cost, and fixed overhead volume variances. Round to the nearest dollar. 3. Have McKnight’s managers done a good job or a poor job controlling materials, labor, and overhead costs? Why? 4. Describe how McKnight’s managers can benefit from the standard cost system.

Requirement 1

MCKNIGHT RECLINERS Flexible Budget

Budget Amounts per Unit Actual Units (Recliners) 1,005 Sales $ 500.00 $ 502,500(d) Variable Manufacturing Costs: Direct Materials 51.00(a) 51,255(e) Direct Labor 92.00(b) 92,460(f) Variable Overhead 30.60(c) 30,753(g) Fixed Manufacturing Costs: Fixed Overhead 62,730 Total Cost of Goods Sold 237,198 Gross Profit $ 265,302

(a) $ 52,275 / 1,025 recliners = $51.00 per recliner (b) $ 94,300 / 1,025 recliners = $92.00 per recliner (c) $ 31,365 / 1,025 recliners = $30.60 per recliner (d) $ 500.00 per recliner × 1,005 recliners = $ 502,500 (e) $ 51.00 per recliner × 1,005 recliners = $ 51,255 (f) $ 92.00 per recliner × 1,005 recliners = $ 92,460 (g) $ 30.60 per recliner × 1,005 recliners = $ 30,753

Requirement 2

Direct Materials Cost Variance = (AC ̶ SC) × AQ = ($8.30 per yard – $8.50 per yard) × 6,300 yards = $1,260 F

Direct Materials Efficiency Variance = (AQ ̶ SQ) × SC = (6,300 yards – 6,030 yards(a)) × $8.50 per yard = $2,295 U

Direct Labor Cost Variance = (AC ̶ SC) × AQ = ($9.40 per DLHr – $9.20 per DLHr) × 9,850 DLHr = $1,970 U

Direct Labor Efficiency Variance = (AQ ̶ SQ) × SC = (9,850 DLHr – 10,050 DLHr(b)) × $9.20 per DLHr = $1,840 F

VOH Cost Variance = (AC ̶ SC) × AQ = ($6.50 per yard – $5.10 per yard) × 6,300 yards = $8,820 U

VOH Efficiency Variance = (AQ ̶ SQ) × SC = (6,300 yards – 6,030 yards(a)) × $5.10 per yard = $1,377 U

FOH Cost Variance = Actual FOH ̶ Budgeted FOH = $64,730 ̶ $62,730 = $2,000 U

FOH Volume Variance = Budgeted FOH ̶ Allocated FOH = $62,730 ̶ $61,506(c) = $1,224 U

(a) 6,150 yards / 1,025 recliners = 6 yards per recliner Thus: 6 yards per recliner × 1,005 recliners = 6,030 yards

(b) 10,250 DLHr / 1,025 recliners = 10 DLHr per recliner Thus: 10 DLHr per recliner × 1,005 recliners = 10,050 DLHr

The $1,260 favorable direct materials cost variance indicates that McKnight’s managers did a good job keeping actual direct materials cost per yard within standard. The $8.30 actual cost per yard was less than the $8.50 standard cost per yard.

The $2,295 unfavorable direct materials efficiency variance and $1,377 unfavorable variable overhead efficiency variance indicate that McKnight’s managers did not do a good job keeping actual usage of direct materials within standard. The 6,300 total yards actually used was greater than the 6,030 total yards allowed to manufacture 1,005 recliners.

The $1,970 unfavorable direct labor cost variance indicates that McKnight’s managers did not do a good job keeping actual direct labor cost per hour within standard. The $9.40 actual cost per direct labor hour was greater than the $9.20 standard cost per direct labor hour.

The $1,840 favorable direct labor efficiency variance indicates that McKnight’s managers did a good job keeping actual usage of direct labor hours within standard. The 9,850 total direct labor hours actually used was less than the 10,050 total direct labor hours allowed to manufacture 1,005 recliners.

The $8,820 unfavorable variable overhead cost variance indicates that McKnight’s managers did not do a good job keeping actual variable overhead cost per yard within standard. The $6.50 actual cost per yard was greater than the $5.10 standard cost per yard (the standard variable overhead allocation rate per yard).

The $2,000 unfavorable fixed overhead cost variance indicates that McKnight’s managers did not do a good job keeping actual total fixed cost within budget. The $64,730 actual total fixed overhead cost was greater than the $62,730 budgeted total fixed overhead cost.

The $1,224 unfavorable fixed overhead volume variance is not a cost variance. It is a volume variance and explains why fixed overhead was underallocated. The variance is unfavorable because the company manufactured fewer recliners (1,005) than budgeted (1,025). Therefore, total fixed overhead cost allocated to recliners was $1,224 less than the total budgeted fixed overhead cost ($61,506 total fixed overhead cost was allocated compared with the $62,730 total budgeted fixed overhead cost).

McKnight’s managers can benefit from the standard costing system in the following ways: • Preparing the master budget. • Setting target levels of performance for flexible budgets. • Identifying performance standards. • Setting sales price of products. • Decreasing accounting costs.

P23-32B Computing standard cost variances and reporting to management

Learning Objectives 3, 4, 5

1. DM Eff. Var. $480 F

Headset manufactures headphone cases. During September 2018, the company produced 106,000 cases and recorded the following cost data: Standard Cost Information Quantity Cost Direct Materials 2 parts $ 0.16 per part Direct Labor 0.02 hours 8.00 per hour Variable Manufacturing Overhead 0.02 hours 11.00 per hour Fixed Manufacturing Overhead ($30,720 for static budget volume of 96,000 units and 1,920 hours, or $16 per hour)

Actual Information Direct Materials (209,000 parts @ $0.21 per part) $ 43,890 Direct Labor (1,620 hours @ $8.10 per hour) 13,122 Variable Manufacturing Overhead 9,000 Fixed Manufacturing Overhead 30,000 Requirements 1. Compute the cost and efficiency variances for direct materials and direct labor. 2. For manufacturing overhead, compute the variable overhead cost and efficiency variances and the fixed overhead cost and volume variances. 3. Headset’s management used better-quality materials during September. Discuss the trade-off between the two direct material variances.

Requirement 1

Direct Materials Cost Variance = (AC ̶ SC) × AQ = ($0.21 per part – $0.16 per part) × 209,000 parts = $10,450 U

Direct Materials Efficiency Variance = (AQ ̶ SQ) × SC = (209,000 parts – 212,000 parts(a)) × $0.16 per part = $480 F

Direct Labor Cost Variance = (AC ̶ SC) × AQ = ($8.10 per DLHr – $8.00 per DLHr) × 1,620 DLHr = $162 U

Direct Labor Efficiency Variance = (AQ ̶ SQ) × SC = (1,620 DLHr – 2,120 DLHr(b)) × $8.00 per DLHr = $4,000 F

(a) 2 parts per case × 106,000 cases = 212,000 parts (b) 0.02 DLHr per case × 106,000 cases = 2,120 DLHr

VOH Cost Variance = Actual VOH − (SC × AQ) = $9,000 − ($11 per DLHr × 1,620 DLHr) = $8,820 F

VOH Efficiency Variance = (AQ ̶ SQ) × SC = (1,620 DLHr – 2,120 DLHr(a)) × $11 per DLHr = $5,500 F

FOH Cost Variance = Actual FOH ̶ Budgeted FOH = $30,000 ̶ $30,720 = $720 F

FOH Volume Variance = Budgeted FOH ̶ Allocated FOH = $30,720 ̶ $33,920(b) = $3,200 F

(a) Calculated in Requirement 1 (b) $16 per DLHr × 2,120 DLHr = $33,920

Requirement 3

There may be trade-offs between the direct materials cost variance and the direct materials efficiency variance. Decisions made by the purchasing manager may affect the direct materials efficiency variance for the production manager. Perhaps Headset used better quality direct materials, indicated by the fact that the $0.21 actual direct materials cost per part was greater than the $0.16 direct materials standard cost per part. Therefore, the direct materials cost variance was $10,450 unfavorable for the 209,000 parts actually purchased. If so, then the better quality direct materials likely contributed to the $480 favorable direct materials efficiency variance (209,000 parts actually used was less than the 212,000 parts allowed for actual production of 106,000 cases). However, the total direct materials variance was $9,970 unfavorable (the $10,450 unfavorable direct materials cost variance minus the $480 favorable direct materials efficiency variance), indicating that the more efficient usage of direct materials did not outweigh the higher cost of the direct materials purchased. However, the higher quality components may result in higher quality and durable final products which may lead to fewer returns and warranty claims due to product failures and higher customer satisfaction.

© 2018 Pearson Education, Inc. 23-60 P23-33B Computing and journalizing standard cost variances Learning Objectives 3, 4, 5, 6 3. VOH Cost Var. $985 F Middleton manufactures coffee mugs that it sells to other companies for customizing with their own logos. Middleton prepares flexible budgets and uses a standard cost system to control manufacturing costs. The standard unit cost of a coffee mug is based on static budget volume of 59,800 coffee mugs per month: Direct Materials (0.2 lbs. @ $0.25 per lb.) $ 0.05 Direct Labor (3 minutes @ $0.14 per minute) 0.42 Manufacturing Overhead: Variable (3 minutes @ $0.06 per minute) $ 0.18 Fixed (3 minutes @ $0.13 per minute) 0.39 0.57 Total Cost per Coffee Mug $ 1.04

Actual cost and production information for July 2018 follows: a. There were no beginning or ending inventory balances. All expenditures were on account. b. Actual production and sales were 62,500 coffee mugs. c. Actual direct materials usage was 11,000 lbs. at an actual cost of $0.17 per lb. d. Actual direct labor usage of 197,000 minutes at a cost of $33,490. e. Actual overhead cost was $10,835 variable and $29,965 fixed. f. Selling and administrative costs were $130,000. Requirements 1. Compute the cost and efficiency variances for direct materials and direct labor. 2. Journalize the purchase and usage of direct materials and the assignment of direct labor, including the related variances. 3. For manufacturing overhead, compute the variable overhead cost and efficiency variances and the fixed overhead cost and volume variances. 4. Journalize the actual manufacturing overhead and the allocated manufacturing overhead. Journalize the movement of all production from Work-in-Process Inventory. Journalize the adjusting of the Manufacturing Overhead account. 5. Middleton intentionally hired more highly skilled workers during July. How did this decision affect the cost variances? Overall, was the decision wise?

SOLUTION

Requirement 1

Direct Materials Cost Variance = (AC ̶ SC) × AQ = ($0.17 per lb. – $0.25 per lb.) × 11,000 lbs. = $880 F

Direct Materials Efficiency Variance = (AQ ̶ SQ) × SC = (11,000 lbs. – 12,500 lbs.(a)) × $0.25 per lb. = $375 F

Direct Labor Cost Variance = (AC ̶ SC) × AQ = ($0.17 per min.(b) – $0.14 per min.) × 197,000 min. = $5,910 U

Direct Labor Efficiency Variance = (AQ ̶ SQ) × SC = (197,000 min. – 187,500 min.(c)) × $0.14 per min. = $1,330 U

(a) 0.2 lbs. per mug × 62,500 mugs = 12,500 lbs. (b) $33,490 total cost / 197,000 minutes = $0.17 cost per minute (c) 3 minutes per mug × 62,500 mugs = 187,500 minutes

Work-in-Process Inventory ($0.25/lb. × 12,500 lbs.) 3,125 Direct Materials Efficiency Variance (from Req. 1) 375 Raw Materials Inventory ($0.25/lb. × 11,000 lbs.) 2,750 Used direct materials.

Work-in-Process Inventory ($0.14/min. × 187,500 min.) 26,250 Direct Labor Cost Variance (from Req.1 ) 5,910 Direct Labor Efficiency Variance (from Req. 1) 1,330 Wages Payable ($0.17/min × 197,000 min.) 33,490 Direct labor costs incurred.

Requirement 3

VOH Cost Variance = Actual VOH − (SC × AQ) = $10,835 − ($0.06 per min. × 197,000 min.) = $985 F

VOH Efficiency Variance = (AQ ̶ SQ) × SC = (197,000 min. – 187,500 min.(a)) × $0.06 per min. = $570 U

FOH Cost Variance = Actual FOH ̶ Budgeted FOH = $29,965 ̶ $23,322(b) = $6,643 U

FOH Volume Variance = Budgeted FOH ̶ Allocated FOH = $23,322(b) ̶ $24,375(c) = $1,053 F

(a) Calculated in Requirement 1 (b) $0.39 per mug × 59,800 mugs = $23,322 (c) $0.13 per min. × 3 min. per mug × 62,500 mugs = $24,375

Date Accounts and Explanation Debit Credit Manufacturing Overhead ($10,835 + $29,965) 40,800 Various Accounts 40,800 Manufacturing overhead costs incurred.

Work-in-Process Inventory ($0.57/mug × 62,500 mugs) 35,625 Manufacturing Overhead 35,625 Manufacturing overhead costs allocated.

Finished Goods Inventory ($3,125 + $26,250 + $35,625) 65,000 Work-in-Process Inventory 65,000 Completed goods transferred.

Variable Overhead Efficiency Variance (from Req. 3) 570 Fixed Overhead Cost Variance (from Req. 3) 6,643 Variable Overhead Cost Variance (from Req. 3) 985 Fixed Overhead Volume Variance (from Req. 3) 1,053 Manufacturing Overhead 5,175 To adjust Manufacturing Overhead.

Requirement 5

Because Middleton hired more skilled workers, the $0.17 actual direct labor cost per minute was greater than the $0.14 direct labor standard cost per minute. Therefore, the direct labor cost variance was $5,910 unfavorable for the 62,500 mugs actually produced. Hiring more skilled direct labor workers could be expected to lead to a favorable direct labor efficiency variance, but this didn’t occur. Instead, the direct labor efficiency variance was $1,330 unfavorable (197,000 minutes of direct labor time actually used was more than the 187,500 direct labor minutes allowed for actual production of 62,500 mugs). Combining the two direct labor variances, the total direct labor variance was $7,240 unfavorable (the $5,910 unfavorable direct labor cost variance plus the $1,330 unfavorable direct labor efficiency variance). Overall, Middleton’s decision to hire more skilled direct labor workers was not wise.

P23-34B Preparing a standard cost income statement

Learning Objective 6

COGS at actual $76,160

Review your results from Problem P23-33B. Middleton’s actual and standard sales price per mug is $5. Prepare the standard cost income statement for July 2018.

MIDDLETON Standard Cost Income Statement For the Month Ended July 31, 2018

Sales Revenue at standard ($5/mug × 62,500 mugs) $ 312,500 Cost of Goods Sold at standard cost (from P23-33B) $ 65,000 Manufacturing Cost Variances (from P23-33B): Direct Materials Cost Variance $ (880) Direct Materials Efficiency Variance (375) Direct Labor Cost Variance 5,910 Direct Labor Efficiency Variance 1,330 Variable Overhead Cost Variance (985) Variable Overhead Efficiency Variance 570 Fixed Overhead Cost Variance 6,643 Fixed Overhead Volume Variance (1,053) Total Manufacturing Cost Variances 11,160 Cost of Goods Sold at actual cost 76,160 Gross Profit 236,340 Selling and Administrative Expenses 130,000 Operating Income $ 106,340

P23-35 Using Excel to prepare a flexible budget performance report

Download an Excel template for this problem online in MyAccountingLab or at http://www.pearsonhighered.com/Horngren. Pilchuck Company manufactures tote bags and has provided the following information for September 2018: Actual Results Static Budget Units 11,000 12,000 Sales Revenue $368,000 $384,000 Variable Costs 183,000 198,000 Contribution Margin 185,000 186,000 Fixed Costs 76,000 77,184 Operating Income $109,000 $108,816 Requirements 1. Prepare a flexible budget performance report, including the heading. Use the ABS function when calculating variances, and use the drop-down selections for F or U when describing the variances. 2. Calculate the Static Budget Variance for operating income, and label it as a F (favorable) or U (unfavorable) variance. SOLUTION

The student templates for Using Excel are available online in MyAccountingLab in the Multimedia Library or at http://www.pearsonhighered.com/Horngren. The solution to Using Excel is available online in MyAccountingLab in the Instructor Resource Center or at http://www.pearsonhighered.com/Horngren.

P23-36 Preparing a flexible budget and performance report

This continues the Piedmont Computer Company situation from Chapter 22. Assume Piedmont Computer Company has created a standard cost card for the PCC model tablet computer, with overhead allocated based on direct labor hours: Direct materials $ 300 per tablet Direct labor 3 hours per tablet at $26 per hour Variable overhead 3 hours per tablet at $5 per hour Fixed overhead $54,000 per month

During the month of September, Piedmont Computer Company incurred the following costs while manufacturing 1,100 PCC model tablets: Direct materials $ 341,000 Direct labor 88,000 Variable overhead 17,600 Fixed overhead 56,320 Requirements 1. Prepare a flexible budget for September for 900, 1,000, and 1,100 PCC model tablets. The tablet has a standard sales price of $675. List variable costs separately. 2. Using 1,000 PCC model tablets for the static budget, prepare a flexible budget performance report for September. Total sales revenue for the month was $767,800. The company sold 1,100 tablets. 3. What insights can the management of Piedmont Computer Company draw from the performance report?

Requirement 1

PIEDMONT COMPUTER COMPANY Monthly Flexible Budget

Budget Amounts per Unit Units 900 1,000 1,100 Sales Revenue $ 675 $ 607,500 $ 675,000 $ 742,500 Variable Costs: Direct Materials 300 270,000 300,000 330,000 Direct Labor* 78 70,200 78,000 85,800 Variable Overhead** 15 13,500 15,000 16,500 Total Variable Costs 353,700 393,000 432,300 Contribution Margin 253,800 282,000 310,200 Fixed Costs 54,000 54,000 54,000 Operating Income $ 199,800 $ 228,000 $ 256,200

*3 hours × $26 per hour ** 3 hours × $5 per hour

PIEDMONT COMPUTER COMPANY Flexible Budget Performance Report For the Month Ended September 30 1 2 3 4 5 (1) – (3) (3) – (5) Budget Flexible Sales Amounts Actual Budget Flexible Volume Static per Unit Results Variance Budget Variance Budget Units 1,100 1,100 1,000 Sales Revenue $ 675 $ 767,800 $ 25,300 F $ 742,500 $ 67,500 F $ 675,000 Variable Costs: Direct Materials 300 341,000 11,000 U 330,000 30,000 U 300,000 Direct Labor* 78 88,000 2,200 U 85,800 7,800 U 78,000 Variable Overhead** 15 17,600 1,100 U 16,500 1,500 U 15,000 Total Variable Costs 446,600 14,300 U 432,300 39,300 U 393,000 Contribution Margin 321,200 11,000 F 310,200 28,200 F 282,000 Fixed Expenses 56,320 2,320 U 54,000 0 54,000 Operating Income $ 264,880 $ 8,680 F $ 256,200 $ 28,200 F $ 228,000

Flexible Budget Variance Sales Volume Variance $ 8,680 F $ 28,200 F

Static Budget Variance $ 36,880 F

*3 hours x $26 per hour **3 hours x $5 per hour

Requirement 3

The increase in sales volume, from the expected sales of 1,000 tablets to the actual sales of 1,100 tablets, resulted in an increase in operating income of $28,200 for the month, the amount of the sales volume variance. Additionally, the tablet sold for an average of $23 each more than expected (total sales revenue of $767,800 / 1,100 tablets = $698 each). However, management should investigate why all flexible budget variances for costs were unfavorable. The actual variable cost per unit exceeds the standard variable cost per unit. Actual fixed costs also exceed the standard budgeted.

Tying It All Together Case 23-1

Before you begin this assignment, review the Tying It All Together feature in the chapter. Kellogg Company manufacturers and markets ready-to-eat cereal and convenience foods including Raisin Bran, Pop Tarts, Rice Krispies Treats, and Pringles. In addition to the raw materials used when producing its products, Kellogg Company also has significant labor costs associated with the products. As of January 2, 2016, Kellogg Company had approximately 33,577 employees. A shortage in the labor pool, regulatory measures, and other pressures could increase the company’s labor cost, having a negative impact on the company’s operating income. Requirements 1. Suppose Kellogg Company noticed an increase in its actual direct labor costs compared to the budgeted amount. How could Kellogg Company investigate this? 2. What is the direct labor cost variance and how would a company calculate this variance? 3. What is the direct labor efficiency variance and how would a company calculate this variance? 4. Suppose that Kellogg Company found an unfavorable total direct labor variance that was due completely to the direct labor cost variance. What measures could Kellogg Company take to control this variance? 5. Suppose that Kellogg Company found an unfavorable total direct labor variance that was due completely to the direct labor efficiency variance. What measures could Kellogg Company take to control this variance?

SOLUTION

Requirement 1 An increase in its actual direct labor cost compared to the budgeted amount would result in a direct labor variance. The direct labor variance should be investigated by exploring both the direct labor cost variance and the direct labor efficiency variance.

Requirement 2 The direct labor cost variance measures the difference between the actual amount paid for direct labor (actual cost) and the amount that should have been paid (standard cost). This variance measures how well the business keeps its unit costs of labor input within standards. It is calculated as (AC – SC) × AQ.

Requirement 3 The direct labor efficiency variance measures the difference between the actual labor hours (actual quantity) and the labor hours that should have been used (standard quantity). This variance measures how well the business uses its human resources. It is calculated as (AQ – SQ) × SC.

Requirement 4 If the total direct labor variance is unfavorable and it is due to the direct labor cost variance, this means that the actual cost of labor was higher than the budgeted cost. Kellogg Company should investigate why its cost of labor increased. For example, did the company pay their employees more than expected? Were there more workers? © 2018 Pearson Education, Inc. 23-70

Requirement 5 If the total direct labor variance is unfavorable and it is due to the direct labor efficiency variance, this means that the company’s workers were not as efficient as the company expected them to be. Kellogg Company should investigate why it took the workers longer to produce the product than expected. For example, were the materials inferior? Was there a training issue? Did machinery break down requiring downtime on the job?

Suppose you manage the local Scoopy’s ice cream parlor. In addition to selling ice cream cones, you make large batches of a few flavors of milk shakes to sell throughout the day. Your parlor is chosen to test the company’s “Made-for-You” system. This new system enables patrons to customize their milk shakes by choosing different flavors. Customers like the new system and your staff appears to be adapting, but you wonder whether this new made-to-order system is as efficient as the old system in which you just made a few large batches. Efficiency is a special concern because your performance is evaluated in part on the restaurant’s efficient use of materials and labor. Your superiors consider efficiency variances greater than 5% to be unacceptable. You decide to look at your sales for a typical day. You find that the parlor used 390 pounds of ice cream and 72 hours of direct labor to produce and sell 2,000 shakes. The standard quantity allowed for a shake is 0.2 pound of ice cream and 0.03 hour of direct labor. The standard costs are $1.50 per pound for ice cream and $8 per hour for labor. Requirements 1. Compute the efficiency variances for direct labor and direct materials. 2. Provide likely explanations for the variances. Do you have reason to be concerned about your performance evaluation? Explain. 3. Write a memo to Scoopy’s national office explaining your concern and suggesting a remedy.

Requirement 1

Direct Labor Efficiency Variance = (AQ ̶ SQ) × SC = (72 DLHr – 60 DLHr(a)) × $8 per DLHr = $96 U

Direct Materials Efficiency Variance = (AQ ̶ SQ) × SC = (390 pounds – 400 pounds(b)) × $1.50 per pound = $15 F

(a) 0.03 DLHr per shake × 2,000 shakes = 60 DLHr (b) 0.2 pound per shake × 2,000 shakes = 400 pounds

Requirement 2

The $15 favorable direct materials efficiency variance indicates that actual usage of direct materials (ice cream) was kept within standard. The 390 pounds of ice cream actually used was less than the 400 pounds allowed to produce 2,000 shakes. Although favorable, the variance is relatively small—only 2.5% under the $600 total direct materials standard allowed to produce 2,000 shakes(a).

The $96 unfavorable direct labor efficiency variance indicates that actual usage of direct labor hours was not kept within standard. The 72 total direct labor hours actually used was more than the 60 total direct

The unfavorable direct labor efficiency variance may be due to employees (1) taking longer to set up equipment and clean it after each order and (2) waiting for customers to choose from the variety of flavors available. While the new “Made-for-You” system may help differentiate Scoopy’s from its competitors, management may have underestimated the system’s cost. The $96 unfavorable direct labor efficiency variance is 20% over the $480 total direct labor standard allowed to produce 2,000 shakes (b). Because this is greater than the 5% tolerated by your superiors, your performance evaluation could be negatively impacted.

(a) 400 pounds × $1.50 per pound = $600 Thus: $15 / $600 = 2.5%

(b) 60 DLHr × $8 per DLHr = $480 Thus: $96 / $480 = 20%

Requirement 3

DATE:

TO: Scoopy’s National Office

FROM:

SUBJECT: “Made-for-You” System

The “Made-for-You” system test has yielded some benefits. Customers enjoy being able to customize their shakes, employees appear to be adapting, and the direct materials efficiency variance is favorable. However, employees are relatively less efficient under the new system. The unfavorable direct labor efficiency variance is 20% over the current direct labor standard allowed for actual shakes produced.

I suggest that the national office consider whether additional training is needed to improve employee efficiency in preparing customized orders. Additionally, the unfavorable direct labor efficiency variance may be due to employees (1) taking longer to set up equipment and clean it after each order and (2) waiting for customers to choose from the variety of flavors available. As such, an assessment of whether existing direct labor standards are appropriate for the new system should also be considered.

Drew Castello, general manager of Sunflower Manufacturing, was frustrated. He wanted the budgeted results, and his staff was not getting them to him fast enough. Drew decided to pay a visit to the accounting office, where Jeff Hollingsworth was supposed to be working on the reports. Jeff had recently been hired to update the accounting system and speed up the reporting process. “What’s taking so long?” Drew asked. “When am I going to get the variance reports?” Jeff sighed and attempted to explain the problem. “Some of the variances appear to be way off. We either have a serious problem in production, or there is an error in the spreadsheet. I want to recheck the spreadsheet before I distribute the report.” Drew pulled up a chair, and the two men went through the spreadsheet together. The formulas in the spreadsheet were correct and showed a large unfavorable direct labor efficiency variance. It was time for Drew and Jeff to do some investigating. After looking at the time records, Jeff pointed out that it was unusual that every employee in the production area recorded exactly eight hours each day in direct labor. Did they not take breaks? Was no one ever five minutes late getting back from lunch? What about clean-up time between jobs or at the end of the day? Drew began to observe the production laborers and noticed several disturbing items. One employee was routinely late for work, but his time card always showed him clocked in on time. Another employee took 10- to 15-minute breaks every hour, averaging about 1 1 each day, but still reported eight hours of 2 direct labor each day. Yet another employee often took an extra 30 minutes for lunch, but his time card showed him clocked in on time. No one in the production area ever reported any “down time” when they were not working on a specific job, even though they all took breaks and completed other tasks such as doing clean-up and attending department meetings. Requirements 1. How might the observed behaviors cause an unfavorable direct labor efficiency variance? 2. How might an employee’s time card show the employee on the job and working when the employee was not present? 3. Why would the employees’ activities be considered fraudulent? SOLUTION

Requirement 1

The direct labor efficiency variance measures actual labor usage compared to standard labor usage. If employees report they are working more hours than they are actually working, then it will appear that production is using more direct labor than necessary. This variance will, therefore, be unfavorable.

Requirement 2

An employee’s time card might show the employee on the job and working when not present if the employee has made arrangements for another employee to clock him or her in. This means that the employees are working together to circumvent company procedures.

The employees’ activities would be considered fraudulent because they are reporting that they worked more hours than they actually did. This false documentation results in the company paying for work that was not completed.

Team Project 23-1

Lynx Corp. manufactures windows and doors. Lynx has been using a standard cost system that bases cost and efficiency standards on Lynx’s historical long-run average performance. Suppose Lynx’s controller has engaged your team of management consultants to advise him or her whether Lynx should use some basis other than historical performance for setting standards. Requirements 1. List the types of variances you recommend that Lynx compute (for example, direct materials cost variance for glass). For each variance, what specific standards would Lynx need to develop? In addition to cost standards, do you recommend that Lynx develop any nonfinancial standards? 2. There are many approaches to setting standards other than simply using long-run average historical costs and quantities. a. List three alternative approaches that Lynx could use to set standards, and explain how Lynx could implement each alternative. b. Evaluate each alternative method of setting standards, including the pros and cons of each method. c. Write a memo to Lynx’s controller detailing your recommendations. First, should Lynx retain its historical data-based standard cost approach? If not, which of the alternative approaches should it adopt?

Requirement 1

Lynx should compute cost variances and efficiency variances for each type of direct material (for example, glass, wood, door handles, and window cranks), each type of direct labor (for example, skilled labor and unskilled labor), and each type of variable manufacturing overhead cost (for example, machine maintenance and utilities). Lynx should also compute a fixed overhead cost variance and fixed overhead volume variance for each type of fixed manufacturing overhead (e.g. rent, salaries, and depreciation).

Finally, Lynx should also develop nonfinancial standards for key factors such as on-time delivery, product quality, and customer satisfaction (for example, the number of defects, inspections, products returned, warranty claims, and customer complaints).

Three alternative approaches that Lynx could use to set standards include the following:

(1) Engineering analysis/time-and-motion studies. This approach reveals the minimum amount of direct materials, direct labor, and manufacturing overhead resources required for production. Using this information, the engineers may be able to suggest reorganization of plant layout or changes in the production process to increase efficiency. Lynx’s own engineers or outside consultants could perform this analysis.

(2) Continuous improvement. Lynx would begin with its historical data-based standards. The company would then tighten these standards incrementally every quarter or year.

(3) Benchmarking. Benchmarking standards are based on “best practices.” Best practices are either internal (within the company) or external (based on other companies). Internal benchmarks are standards from the best practice within the company. If this plant is not the most efficient in the company, then benchmarks could be adopted from the most efficient of the company’s other plants. External benchmarks are standards based on the best practice of other companies. Lynx might be able to obtain benchmark data from industry trade publications or from consultants. Or Lynx might enter into a partnering relationship with another company, where the partner companies exchange benchmark information.

Requirement 2, cont. Part b

(1) Engineering analysis/time-and-motion studies. This approach usually allows for unavoidable waste and spoilage, but it could result in tight, or difficult- to-achieve, standards. Employees who believe that standards are not attainable may be demoralized. If Lynx uses outside consultant engineers, this is a costly approach. However, the analyses often identify opportunities for increasing production efficiency, which could make the company more profitable.

(2) Continuous improvement. Ever-tightening standards can give employees incentives to increase efficiency. This approach is inexpensive, because it starts with the existing historical data-based standards, and then simply requires that these be tightened by certain amounts each quarter or year. A problem with this approach is that after some point, further reductions may not be possible. Management must be careful not to make demands that employees believe are unattainable.

(3) Benchmarking. Using “best practice” as a standard gives employees incentives to increase efficiency. Employees should see these standards as attainable, because others have attained these standards. Internal benchmark information is easier and less expensive to obtain. External benchmark data are inexpensive if obtained from industry trade publications or from partnering relationships, but can be expensive to obtain from consultants.

MEMO

DATE: TO: Controller, Lynx Corporation FROM: ______, Management Consultants SUBJECT: Standard Costs

We recommend that Lynx move from its historical data-based standard cost approach to adopt one of the following alternative approaches:

(1) Engineering analysis/time-and-motion studies. (2) Continuous improvement (3) Benchmarking (best practices).

Any of these three approaches should provide employee incentives to reduce costs and increase operating efficiency. Without more information on the costs of each approach, we cannot definitively recommend a single method.

However, we suggest that Lynx examine trade publications for relevant benchmark data, and explore the possibilities of partnering with other manufacturers to obtain external benchmark data. If benchmark data are too costly or impossible to obtain, then we recommend conducting time-and-motion studies in order to set tight, but achievable, standards. In future years, these standards could form the baseline for continuous improvement adjustments that would give employees incentives to increase efficiency.

Communication Activity 23-1

In 75 words or fewer, explain what a cost variance is and describe its potential causes. A cost variance measures how well a company keeps unit costs of production inputs within standards. The cost variance is the difference in costs (actual cost per unit minus standard cost per unit) of an input, multiplied by the actual quantity used of the input. A cost variance is favorable (unfavorable) if the actual unit cost of an input (direct materials and direct labor) is less (greater) than the input’s expected standard unit cost.