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8 Chapter Performance Evaluation Answers to Questions 1. A static budget is based on the expected or planned volume of activity. An example of a static budget would be the master budget prepared for planning purposes. Flexible budgets differ from static budgets in that they show the estimated amount of revenues and costs that are planned at a variety of different levels of activity. Static budgets are used for planning purposes in determining labor, material, cash, and equipment needs for a variety of different potential activity levels. Flexible budgets are used also for performance evaluation. Since flexible budgets can be prepared for the actual level of activity, volume influences on budget variances can be isolated allowing departments, managers, or employees to be evaluated on the price and usage of materials, labor, and overhead. These are factors over which they have control and would be reasonable measures of performance. Mr. Smith is assessing his performance based on a comparison between a static budget and actual results. Since a static budget is based on the planned level of activity, Mr. Smith s numbers could be the result of a decrease in production. The volume of sales determines the level of production. Costs would be less if fewer units were produced than planned. To judge Mr. Smith s performance fairly, his results should be compared with a flexible budget in order to eliminate the effects of sales volume over which Mr. Smith has no control. Sales variances are favorable when actual sales are greater than planned sales and are unfavorable when actual sales are less than planned sales. Cost variances are favorable when actual costs are less than planned costs and are unfavorable when actual costs are greater than planned costs. 2. 3. 8-1 Chapter 8 Performance Evaluation 4. Many circumstances at the production level could affect Joan s sales. Low quality control in the production process could lead to lower quality goods that are difficult to sell. Delays in the production process could affect the availability of products and inhibit sales volume. Failures in the production department to satisfy customer specifications could also limit sales. Careful investigation of significant sales volume variances can substantiate who is responsible for poor sales performance. To determine volume variances a static budget based on planned volume is compared to a flexible budget based on actual volume. When actual volume is greater, variable costs are planned to be greater under the flexible budget. Variable costs increase proportionately with volume increases. Since sales revenues also increase proportionately with increases in volume, the increase in costs is off set by an increase in volume, thereby resulting in a higher contribution margin. Unfavorable variable cost volume variances should not be interpreted as poor performance until there is a significant decrease in contribution margin. If the increase in volume affects costs per unit, there may be some justification for concern. Sales revenues could increase because of either an increase in sales volume or an increase in the sales price. The increase in sales volume could have resulted from the actions of the marketing manager or could have resulted from circumstances or decisions that were outside the manager's control. For instance, the increase in sales volume may have been the result of a marketwide increase in consumer demand, not the result of decisions made by the marketing manager to lure customers away from competitors. The increase in sales could also have been the result of the marketing manager lowering prices, which may or may not have been profitable. Only if the increased demand was of greater magnitude than the decrease in price, accompanied by an increase in contribution margin, would the lowering of sales prices be reason to congratulate the marketing manager. 5. 6. 8-2 Chapter 8 Performance Evaluation 7. The amount of fixed costs will remain the same under planned or actual volume. Based on this cost behavior when actual volume is greater than planned, there will be a decrease in the fixed cost per unit. This decrease in fixed unit costs represents the principle of operating leverage. Operating leverage means that with the existence of fixed costs, percentage increases in sales volume result in significantly greater percentage increases in profitability. Therefore, when actual volume is greater than planned, more dramatic increases in profitability can be planned because of operating leverage. Flexible budget variances are determined by taking the difference between flexible budget amounts (based on standard per unit costs and actual volume) and actual amounts (based on actual per unit costs and actual volume). The resultant variances are caused by differences between the standard and actual per unit costs since the volume of activity is the same for both amounts. To determine if the marketing department s variances are favorable or unfavorable overall, the combination of variances requires analysis. The magnitude of the price variance versus the magnitude of the volume variance would have to be compared. If the magnitude of the unfavorable volume variance is less than the magnitude of the favorable price variance, then raising prices greater than was planned would have been a good strategy even though actual consumer demand was lower than planned. The results of any one variance cannot be interpreted in isolation. The combination of all significant variances needs consideration in determining good or bad performance. 8. 9. 8-3 Chapter 8 Performance Evaluation 10. Standards represent what should be price, cost, and quantity per unit amounts based on a certain set of anticipated circumstances. Effective standard setting requires experience, judgment, and predictive capacity for price, cost, and quantity decisions. Historical data provides a good starting point for their establishment. The historical data is then revised based on relevant information and other considerations. Information to be considered would include: changes in technology, plant layout, methods of production, and worker productivity; engineering reports based on research to establish efficient performance of work tasks, or efficient utilization of materials; labor, purchase, and transportation contracts; production demands to determine volume and the need for overtime. Behavioral considerations with regard to the extent of employee participation in standard setting and the desired level of difficulty must also be taken into account. The three ranges of difficulty in standard setting are as follows: Ideal standards These standards represent perfection with no allowances for normal materials waste and spoilage, and labor inefficiencies. These standards are unattainable and are not useful for motivating most employees. Practical standards Standards that can be achieved with a reasonable degree of effort. They allow for normal levels of inefficiency in materials and labor usage. Since they represent attainable goals, they have the most motivational appeal to employees. Lax standards Standards that represent easily attainable goals that can be accomplished with minimal effort. They lack motivational appeal for most employees because they require minimal effort and result in continual success. 11. 8-4 Chapter 8 Performance Evaluation 12. Carl is right. Not all variances can be investigated and to try to do so would be inefficient use of management talent. Several factors are important to consider in determining which variances merit investigation. The first of these factors is materiality. Only the material favorable and unfavorable variances should be investigated. Materiality guidelines in terms of set dollar or percentage limits can indicate which variances to investigate. The frequency of occurrence of the variance is another important consideration. A small variance that is repeated throughout the year can amount to a large significant variance when the total annual amount is considered. The capacity to control variances by corrective action must be considered. Variances that are not controllable should not monopolize a manager s time. Finally, there are certain items that permit management abuse and variances associated with these items need close investigation. Expenditures on maintenance, research and development, and advertising can be shortchanged to produce favorable variances but the reductions may have long-term adverse impacts on profitability. The primary benefit of using a standard cost system is the promotion of the efficient use of management talent to control costs. Management can identify areas requiring special analyses, which facilitates the practice of management by exception. The plant manager seems to be overreacting. Many factors that are not under the control of the supervisor may have caused the unfavorable usage variance. For example, the standard may be unrealistically high or the materials may have been inferior because the purchasing department compromised quality for a lower price. More importantly, a standard cost system should be used to help personnel improve performance. If it is used in a threatening or abusive manner, it will have a negative effect on motivation that will outweigh its potential benefits. Favorable as well as unfavorable variances should be investigated. For example, a favorable materials variance may indicate that employees are sacrificing quality in an effort to save materials. Favorable variances do not always imply positive results. The two factors that affect the total materials and labor variances are price and quantity. 13. 14. 15. 16. 8-5 Chapter 8 Performance Evaluation 17. The company s purchasing agent is normally held responsible for price variances. Some factors that are beyond his control that could cause unfavorable price variances include: suppliers charging higher prices, strikes that force the use of alternative materials or transportation modes, rush orders, and changes in planned quantities to be produced. The use of semiskilled employees to perform highly skilled tasks or vice versa could result in labor price variances even when the established rate per hour is paid to employees. Production department supervisors are normally held responsible for labor usage variances. When actual volume is lower than planned volume, fixed overhead costs must be spread over fewer units than anticipated. This results in a higher cost per unit of product. The higher cost per unit is caused by a failure to take advantage of the economies of scale with higher volumes, thus resulting in an unfavorable overhead volume variance. An unfavorable volume variance signifies the underutilization of facilities rather than over- or under-spending. When actual fixed overhead costs are less than budgeted fixed overhead costs, a favorable overhead spending variance will result. 18. 19. 20. 21. 8-6 Chapter 8 Performance Evaluation Exercise 8-1A Item to Classify Sales volume Sales price Materials cost Materials usage Labor cost Labor usage Fixed cost spending Fixed cost per unit (volume) Standard 40,000 units $3.60 per unit $2.90 per pound 91,000 pounds $10.00 per hour 61,000 hours $400,000 $3.20 per unit Actual 42,000 units $3.63 per unit $3.00 per pound 90,000 pounds $9.60 per hour 61,800 hours $390,000 $3.16 per unit Type of Variance Favorable Favorable Unfavorable Favorable Favorable Unfavorable Favorable Favorable Exercise 8-2A Item Sales revenue Cost of goods sold Material purchases at 5,000 pounds Materials usage Sales price Production volume Wages at 4,000 hours Labor usage at $16 per hour Research and development expense Selling and administrative expenses Budget Actual Variance F or U $490,000 $506,000 $16,000 F $385,000 $360,000 $25,000 F $275,000 $280,000 $ 5,000 U $180,000 $178,000 $2,000 F $500 $489 $11 U 950 units 900 units 50 units U $60,000 $58,700 $1,300 F $96,000 $97,000 $1,000 U $22,000 $25,000 $3,000 U $49,000 $40,000 $9,000 F Exercise 8-3A a. Master Price / Cost Budget per Unit 1,100 Units Sales $10 $11,000 Variable manufacturing $4 (4,400) Contribution margin 6,600 Fixed manufacturing (4,000) Fixed selling and admin. (1,600) Net income $ 1,000 b. Flexible Budget 1,200 Units $12,000 (4,800) 7,200 (4,000) (1,600) $ 1,600 Exercise 8-4A Master Budget 8-7 Flexible Budget a. & b. Volume Chapter 8 Performance Evaluation Sales Variable manufacturing Contribution margin Fixed manufacturing Fixed selling and admin. Net income c. 1,100 Units $11,000 (4,400) 6,600 (4,000) (1,600) $ 1,000 1,200 Units $12,000 (4,800) 7,200 (4,000) (1,600) $ 1,600 Variances $1,000 F 400 U 600 F 0 0 600 F Since the sales price and cost per unit are the same for both the master and flexible budgets, the cause of the variances is attributable solely to the fact that the sales volume was 100 units more than planned. The favorable $600 sales variance suggests that it is beneficial to increase sales. However, more information is needed to confirm this conclusion. As stated in the problem, the increase in sales may have been attained by lowering the price which could result in negative consequences. The unfavorable $400 variable manufacturing cost variance is misleading. The total amount of variable cost is expected to increase when volume increases. This variance is expected and not necessarily a bad thing. Upper-level marketing managers are normally responsible for the sales volume variances. The fixed costs in both the master and flexible budgets are estimates. Fixed costs are estimated to be the same regardless of the volume of production and sales. Accordingly, no variance between the master and flexible budgets is expected for fixed costs. Master Budget $4,000 1,600 $5,600 1,100 $5.09 Flexible Budget $4,000 1,600 $5,600 1,200 $4.67 d. e. Fixed manufacturing Fixed selling and admin. Total fixed cost (a) Units (b) Cost per unit (a b) Exercise 8-4A (continued) The increase in sales volume acts to reduce the fixed cost per unit, thereby increasing profitability. The effect on net income will be magnified as a result of operating leverage. However, the result of initially underestimating volume could result in overpricing the company s product. This could have an ultimate unfavorable effect be8-8 Chapter 8 Performance Evaluation cause the company could lose market share to competitors who offer lower prices. 8-9 Chapter 8 Performance Evaluation Exercise 8-5A Flexible Budget 1,200 Units $12,000 (4,800) 7,200 (4,000) (1,600) $ 1,600 Actual Cost at 1,200 Units $11,5201 (4,920)2 6,600 (3,800) (1,700) $ 1,100 a. & b. Flexible Budget Variances $480 U 120 U 600 U 200 F 100 U $500 U Sales Variable manufacturing Contribution margin Fixed manufacturing Fixed selling and admin. Net income 1 2 Actual sales: $9.60 x 1,200 units = $11,520 Actual variable cost: $4.10 x 1,200 units = $4,920 c. The unfavorable flexible budget sales variance results from the fact that products were actually sold at a price below what was planned. To properly interpret this result, you must also consider the sales volume variance. As previously shown in Exercise 8-4A, the sales volume variance was $1,000 favorable. A rational explanation for the two variances is that management sought to increase sales volume by lowering cost. The strategy was successful because the reduction in sales dollars caused by selling products at a lower price (i.e., $480 flexible budget variance) was more than offset by the increase in sales volume (i.e., $1,000 favorable sales volume variance), and the total contribution margin (using standard costs) increased. The variable manufacturing cost variance (i.e., $120) unfavorable is normally the responsibility of the purchasing agent or production supervisor. The variance suggests that either the purchasing agent paid more than planned or that employees used more than the planned amount of resources. Similarly, the fixed manufacturing cost variance suggests that less was spent than was planned to be spent. The unfavorable fixed selling and administrative cost variance indicates that more than planned was spent for these fixed costs. A variety of managers may be responsible for fixed cost variances. Exercise 8-6A Flexible Budget 35,000 Hours 8-10 Flexible Budget 40,000 Hours Flexible Budget 45,000 Hours Chapter 8 Performance Evaluation Sales ($200/hr) Variable cost ($90/hr) Contribution margin Fixed cost Net income Exercise 8-7A a. $7,000,000 (3,150,000) 3,850,000 3,000,000 $ 850,000 $8,000,000 (3,600,000) 4,400,000 3,000,000 $1,400,000 $9,000,000 (4,050,000) 4,950,000 3,000,000 $1,950,000 Master Budget 40,000 Hours Sales ($100 per hour) $4,000,000 b. Flexible Budget 42,000 Hours $4,200,000 Flexible Budget Volume 42,000 Hours Variance $4,200,000 $200,000 F Sales 1 Actual Revenue at 42,000 Hours $3,780,0001 Flexible Budget Variance $420,000 U Actual Sales: $90 x 42,000 hours = $3,780,000 c. Reducing the sales price was unprofitable. The favorable volume variance is less than the unfavorable flexible budget variance. The result is a lower amount of total sales than was planned. Exercise 8-8A a. b. The production department may be producing goods that are inferior in quality and therefore difficult to sell. The marketing department could lack the leadership necessary to motivate the sales staff to accomplish otherwise attainable objectives. 8-11 Chapter 8 Performance Evaluation c. Lower sales volume will cause the cost per unit to increase. Given that the company desires to earn a certain profit above cost, raising the cost per unit would diminish the company s ability to lower its sales price. Exercise 8-9A The production supervisor s response explains only part of the variance. Variable manufacturing cost is planned to be $100,800 at a volume of 4,200 units (i.e., $24 x 4,200 units). Since actual cost was $101,640, there remains a $840 unfavorable flexible budget variance (i.e., $101,640 $100,800) that is not explained by an increase in the planned volume of activity. Exercise 8-10A a. The variance is not calculated properly. The variance has been calculated on the basis of the static budget (i.e., 4,000 sandwiches). The variance should be calculated on the basis of a flexible budget (i.e., 4,500 sandwiches). Based on a flexible budget the standard quantity of ham used should be 27,000 ounces (i.e., 4,500 sandwiches x 6 ounces). The flexible budget variance is $112.50 unfavorable [i.e., (27,450 27,000) x $0.25). b. There are numerous explanations that could explain the variance. Some of these explanations include: (1) sandwich makers used too much meat on the sandwiches (2) sandwich makers or other employees ate or otherwise stole some of the ham, (3) the ham purchased was of a low quality and some of it had to be thrown away, (4) the cashier failed to charge customers for some sandwiches, (5) some sandwiches were dropped on the floor and had to be thrown away. Exercise 8-11A a. b. c. |Actual cost per unit Standard cost per unit | x Actual units |$1.83 $1.92| x 800 = $72 Favorable |Actual price Standard price | x Actual quantity |$0.30 $0.32| x 6.1 x 800 = $97.60 Favorable |Actual quantity Standard quantity | x Standard price | (6.1 x 800) (6 x 800) | x $0.32 = $25.60 Unfavorable 8-12 Chapter 8 Performance Evaluation d. Price variance Usage variance Total variance $97.60 Favorable 25.60 Unfavorable $72.00 Favorable Exercise 8-12A a. b. |Actual price Standard price | x Actual quantity |$0.25 $0.30| x (4.8 x 25,000) = $6,000 Favorable |Actual quantity Standard quantity| x Standard price | (4.8 x 25,000) (4 x 25,000) | x $0.30 |120,000-100,000| x $0.30 = $6,000 Unfavorable In a normal situation, the usage variance reflects the efficiency of the production department. However, the measurement can also be affected by other departments activities. For example, the purchasing agent could have obtained a low price by purchasing low quality oranges. Some of the low-quality oranges were not usable in making the fruit baskets. This waste led to the material usage variance. c. Exercise 8-13A a. The personnel manager may have attained a favorable rate variance by hiring people who were not fully qualified to do the job. Since these employees were not fully qualified they required more than the standard time necessary to complete the work, thereby causing the unfavorable usage variance. The production manager lacked the leadership necessary to motivate the workers to accomplish otherwise attainable objectives. b. Exercise 8-14A a. Labor Variance Information Table Standard cost per return ($50 x 4.0) Actual cost per return ($46 x 4.4) Actual no. of returns |Actual cost Standard cost| x Actual units |$202.40 $200.00| x 600 = $1,440 Unfavorable b. |Actual price Standard price| x Actual hours |$46 $50| x (4.4 x 600) = $10,560 Favorable Amounts $200.00 $202.40 600 8-13 Chapter 8 Performance Evaluation c. |Actual hours Standard hours| x Standard price | (4.4 x 600) (4.0 x 600) | x $50 |2,640 2,400| x $50 = $12,000 Unfavorable The lower than planned labor price suggests that the firm may have hired less qualified personnel. These under-qualified individuals took longer to accomplish the task of preparing a tax return. d. Exercise 8-15A a. Standard hours are 210 (i.e., 840 x .25) Actual hours are 252 (provided in the problem) Usage variance = [(Standard hours Actual hours) x Standard price] = $336 (210 252) x Standard price = $336 Standard price = $336 42 = $8 Since the actual price ($7.50 per hour) used is less than the standard price ($8.00 per hour), the variance is favorable. b. Exercise 8-16A a. b. |Actual cost Standard cost| x Actual hours |$9.60 $10.00| x 77,000 = $30,800 favorable Many different variable overhead costs are pooled together in order to establish the predetermined variable overhead rate. Accordingly, price and usage variances are difficult to interpret. Does a favorable price variance mean that the cost of supplies, utilities, indirect labor, or some other item was obtained at a favorable price? To be useful, price or usage variances must be calculated for each individual overhead cost. Exercise 8-17A 8-14 Chapter 8 Performance Evaluation a. Actual overhead cost Budgeted overhead cost (9,000 x $24) Spending variance $228,000 216,000 $ 12,000 Unfavorable The spending variance measures whether the actual amount spent on fixed cost was more or less than the planned amount. Many different managers could be responsible for the fixed cost spending variance. For example, upper management may be responsible for paying more than planned for rent on the manufacturing facility while the production manager may be responsible for paying more than planned for a supervisor s salary. b. Budgeted overhead cost (9,000 x $24) Applied overhead (8,000 x $24) Volume variance $216,000 192,000 $ 24,000 Unfavorable The volume variance provides insight into how effectively plant facilities have been used. When facilities are being used at full capacity, volume will be high and cost per unit will be low. When facilities are under-utilized, volume will be low and cost per unit will be high. Upper-level marketing managers are normally responsibility for volume variances because the level of production is driven by the volume of sales. Problem 8-18A a. & b. Number of units Sales revenue Per Unit Standards $36.00 Master Budget 30,000 $1,080,000 (270,000) (135,000) (189,000) (216,000) 270,000 (135,000) Flexible Budgets 29,000 31,000 $1,044,000 (261,000) (130,500) (182,700) (208,800) 261,000 (135,000) $1,116,000 (279,000) (139,500) (195,300) (223,200) 279,000 (135,000) Variable manufacturing costs Materials $9.00 Labor $4.50 Overhead $6.30 Variable G,S,&A $7.20 Contribution margin Fixed costs Manufacturing 8-15 Chapter 8 Performance Evaluation G,S,&A Net income c. & d. Number of units Sales revenue Per Unit Standards $36.00 $ (54,000) 81,000 (54,000) $ 72,000 31,000 Flexible Budget $1,116,000 (279,000) (139,500) (195,300) (223,200) 279,000 (135,000) (54,000) $ 90,000 $ (54,000) 90,000 30,000 Master Budget $1,080,000 (270,000) (135,000) (189,000) (216,000) 270,000 (135,000) (54,000) $ 81,000 Volume Variances $36,000 F 9,000 4,500 6,300 7,200 9,000 0 0 $ 9,000 U U U U F Variable manufacturing costs Materials $9.00 Labor $4.50 Overhead $6.30 Variable G,S,&A $7.20 Contribution margin Fixed costs Manufacturing G,S,&A Net income F e. The sales volume variances are useful in determining how changes in sales volume affect revenues and cost. Since the flexible budget is computed at standard prices and costs, the variances do not provide insight into differences between standard prices and costs and actual prices and costs. 8-16 Chapter 8 Performance Evaluation Problem 8-19A a. & b. Number of units Sales revenue Variable manuf. costs Materials Labor Overhead Variable G,S,&A Contribution margin Fixed costs Manufacturing G,S,&A Net income c. 31,000 Flexible Budget $1,116,000 (279,000) (139,500) (195,300) (223,200) 279,000 (135,000) (54,000) $ 90,000 31,000 Actual Flexible Budget Results Variances $1,085,000 $31,000 U (285,200) (136,400) (196,850) (217,000) 249,550 (120,000) (60,000) $ 69,550 6,200 3,100 1,550 6,200 29,450 15,000 6,000 $20,450 U F U F U F U U Upper-level marketing managers are responsible for the sales variance. These managers are normally responsible for establishing the sales price. In this case the actual sales price is less than the planned sales price, thereby causing an unfavorable flexible budget variance ($31,000). Mid-level production supervisors are normally responsible for the variable manufacturing cost variances. The unfavorable materials and overhead variances could have been caused by waste or by paying more than the standard price. Problem 8-19A (continued) 8-17 Chapter 8 Performance Evaluation Many different managers may be responsible for fixed manufacturing cost variances. For example, the personnel manager may be responsible for supervisory salaries while production managers may be responsible for the cost of equipment rentals. In this case, the favorable variance could have been caused by negotiating favorable rental rates. Many different managers may be responsible for fixed selling and administrative costs. For example, a marketing manager may be responsible for advertising costs while the manager of the electronic data processing center may be responsible for purchases of computer equipment. The unfavorable variance could have been generated when a manager paid more than budgeted for equipment purchases. Problem 8-20A a. Master Budget Standard $80/hr Revenue Costs @ 30,000 Hours $2,400,000 $40/hr $7.20/hr $4.30/hr (1,200,000) (216,000) (129,000) 855,000 (525,000) (150,000) $ 180,000 b. Flexible Budget $75/hr Revenue @ 38,000 Hours $2,850,000 (1,520,000) (273,600) (163,400) 893,000 (525,000) (150,000) $ 218,000 c. Flexible Budget $85/hr Revenue @ 25,000 Hours $2,125,000 (1,000,000) (180,000) (107,500) 837,500 (525,000) (150,000) $ 162,500 Services revenue Variable costs: Labor cost Overhead cost G, S, & A cost Contribution margin Fixed costs: Repair facility G, S, & A cost Net income d. Since the service rate of $75 per hour may generate the highest net income, this pricing strategy should be adopted. 8-18 Chapter 8 Performance Evaluation Problem 8-24A a. Materials Variance Information Table Standard price per pound Actual price per pound Standard quantity for flexible budget (3 pounds per unit x 4,200 units) Actual quantity used (2.9 pounds per unit x 4,200 units) Materials price variance: Actual price Standard price x Actual quantity =price variance $2.10 $2.00 x 12,180 pounds = $1,218 Unfavorable The variance is unfavorable because the actual price was higher than the standard price. Materials usage variance: Actual quantity Standard quantity x Standard price = Usage variance Amounts $2.00 $2.10 12,600 pounds 12,180 pounds b. 12,180 12,600 x $2.00 = $840 Favorable The variance is favorable because the actual quantity used was less than the standard quantity. c. Labor Variance Information Table Standard price per hour Actual price per hour Standard hours for flexible budget (2 hours per unit x 4,200 units) Actual hours used (2.2 hours per unit x 4,200 units) Amounts $4.00 $3.80 8,400 hours 9,240 hours 8-19 Chapter 8 Performance Evaluation Problem 8-24A (continued) d. Labor price variance: Actual price Standard price x Actual hours = Price variance $3.80 $4.00 x 9,240 hours = $1,848 Favorable The variance is favorable because the actual price paid for labor was less than the standard price. Labor usage variance: Actual hours Standard hours x Standard price = Usage variance 9,240 8,400 x $4.00 = $3,360 Unfavorable The variance is unfavorable because the actual hours used was more than the standard hours. e. Predetermined overhead rate = Total Expected overhead costs Total Expected units = $4.50 per unit Predetermined overhead rate = f. $18,000 4,000 Overhead spending variance = Actual overhead Budgeted overhead Overhead spending variance = $17,600 $18,000 Overhead spending variance = $400 Favorable The variance is favorable because the company spent less than it planned to spend. Overhead volume variance = Budgeted overhead Applied overhead Overhead volume variance = $18,000 ($4.50 x 4,200) Overhead volume variance = $900 Favorable The variance is favorable because the company produced more units than planned thereby reducing the fixed cost per unit. g. Problem 8-25A 8-20 Chapter 8 Performance Evaluation a. Materials Variance Information Table Standard price per pound Actual price per pound Standard quantity for flexible budget (2 pounds per unit x 41,200 units) Actual quantity used Materials price variance: Amounts $1.80 $1.85 82,400 pounds 84,460 pounds b. Actual price Standard price x Actual quantity = Price variance $1.85 $1.80 x 84,460 pounds = $4,223 Unfavorable The variance is unfavorable because the actual price was higher than the standard price. Materials usage variance: Actual quantity Standard quantity x Standard price = Usage var. 84,460 82,400 x $1.80 = $3,708 Unfavorable The variance is unfavorable because the actual quantity was more than the standard quantity. c. Labor Variance Information Table Standard price per hour Actual price per hour Standard hours for flexible budget (3 hours per unit x 41,200 units) Actual hours used Labor price variance: Actual price Standard price x Actual hours $8.10 $8.00 x 119,480 hours =Price variance = $11,948 Unfavorable Amounts $8.00 $8.10 123,600 hours 119,480 hours d. The variance is unfavorable because the actual price paid was more than the standard price. Problem 8-25A (continued) Labor usage variance: 8-21 Chapter 8 Performance Evaluation Actual hours Standard hours x Standard price = Usage variance 119,480 123,600 x $8.00 = $32,960 Favorable The variance is favorable because the actual hours were fewer than the standard hours. e. Predetermined overhead rate = Total Planned overhead costs Total Planned units Predetermined overhead rate = f. $936,000 40,000 = $23.40 per unit Spending variance = Actual overhead Budgeted overhead Spending variance = $984,000 $936,000 = $48,000 Unfavorable The variance is unfavorable because actual fixed overhead costs were more than the budgeted fixed overhead. Overhead volume variance = Budgeted overhead Applied overhead Overhead volume variance = $936,000 ($23.40 x 41,200) =$28,080 Favorable The variance is favorable because the company produced more units than planned thereby reducing the fixed cost per unit. g. Actual costs will appear on the company s income statement. Accordingly, the amount of gross margin is computed as follows: Sales Cost of goods sold: Cost of materials ($1.85 x 84,460) Cost of labor ($8.10 x 119,480) Cost of overhead Gross margin $2,400,000 (156,251) (967,788) (984,000) $ 291,961 Problem 8-26A a. |SQ AQ| x SP = Usage variance |1,800 AQ| x $5 = $200 Favorable 8-22 Chapter 8 Performance Evaluation |1,800 AQ| = 40 Since the variance is favorable, the actual quantity used must be less than the standard quantity. AQ = 1,760 pounds b. |SP AP| x AQ = Price variance |$5 AP| x 1,760 = $176 Unfavorable |$5 AP| = $0.1 Since the variance is unfavorable, the actual price must be greater than the standard price, AP = $5.10 c. |SHrs AHrs| x SP = Usage variance |3,600 AHrs| x $9 = $900 Unfavorable |3,600 AHrs| = 100 Since the variance is unfavorable, the actual labor hours used must be more than the standard hours. AHrs = 3,700 d. |SP AP| x AHrs = Price variance |$9 AP| x 3,700 = $1,480 Favorable |$9 AP| = $0.40 Since the variance is favorable, the actual price must be less than the standard price. AP = $8.60 8-23 Chapter 8 Performance Evaluation Problem 8-27A a. and b. Cost Direct material Direct labor Overhead Total per candle c. and d. Cost Direct material Direct labor: Overhead Total per candle e. Cost Direct material: Price var. Usage var. Direct labor Price var. Usage var. Computation ($.75/lb. - $.60/lb) x 37,000 lbs. (38,400 lbs.* - 37,000 lbs.) x $.75/lb. *1.6 lbs./ unit x 24,000 actual units ($6/hr - $5.75/hr) x 46,000 hrs (48,000 hrs.* 46,000 hrs.) x $6/hr. *2 hrs/unit x 24,000 actual units Variance = $5,550 (F) = $1,050 (F) = $11,500 (F) = $12,000 (F) Computation 37,000 lbs x $0.60/lb. = $22,200 $22,200/24,000 actual units 46,000 hrs. x $5.75/hr. = $264,500 $264,500/24,000 actual units $130,000/24,000 actual units = = = = Actual Cost per Unit $ 0.93 $11.02 $ 5.42 $17.37 Computation 1.6 lbs. per unit x $.75 per lb. 2 hours per unit x $6.00 per hour $126,000/30,000 = = = = Standard Cost per Unit $ 1.20 $12.00 $ 4.20 $17.40 Problem 8-27A (continued) 8-24 Chapter 8 Performance Evaluation The fact that all of the variances are favorable does not mean they can be ignored. All of the variances need to be considered for investigation. Which ones are actually investigated depend on judgment. Factors that bear on that judgment are materiality, frequency, capacity to control, and susceptibility to management abuse. The favorable variances could be an indication that everyone is doing a good job. However, it could also indicate that the standards were set too low. Employees may be putting slack in the budgeted cost thereby assuring that variances are favorable. f. Fixed OH cost Spending var. Volume var. Computation $126,000 Bud. OH $130,000 Actual OH $126,000 M. Bud. $100,800 Applied OH* *$126,000/30,000 = $4.2 std cost per unit $4.2 x 24,000 actual units = $100,800 Variance $4,000 (U) $25,200 (U) The unfavorable spending variance indicates that more was spent for overhead than was budgeted or planned. The unfavorable volume variance occurred because fewer units were produced than planned. Therefore, the cost per unit for fixed overhead was greater than planned. With high fixed cost a company should utilize its facilities to produce a high volume in order to lower the cost per unit of production. If fewer units are produced than planned, the company is under-utilizing its facilities and will incur an unfavorable volume variance. g. The favorable price and usage variances are offset by the fact that the volume variances were unfavorable. Accordingly, the difference between actual and standard cost per unit is minimal. Problem 8-28A 8-25 Chapter 8 Performance Evaluation a. Allocated funds Expenses: Variable expenses Meals Postage Fixed expenses Facility Printing Decorations Gift Publicity Total expenses Surplus(deficit) Master Budget $21,210 16,520 1,170 1,000 950 840 130 600 21,210 $ 0 Flexible Budget $21,210 19,116 (1) 1,560 (2) 1,500 (3) 950 840 130 600 24,696 $ (3,486) = Activity Variance 2,596 U 390 U 500 U 0 0 0 0 3,486 U $ 3,486 U (1) 1,620 x $11.80 = $19,116 (2) 4,000 x $0.39 = $1,560 (3) Higher charge due to higher attendance b. Allocated funds Expenses: Variable expenses Meals Postage Fixed expenses Facility Printing Decorations Gift Publicity Total expenses Surplus (deficit) Flexible Budget $21,210 19,116 1,560 1,500 950 840 130 600 24,696 $ (3,486) Actual Results $21,210 20,250 1,560 1,500 950 840 130 600 25,830 $ (4,620) $1,134 U 0 0 0 0 0 0 1,134 U $1,134 U = Flexible Variances Problem 8-28A (continued) c. The $3,730 (i.e., $20,250 $16,520) variance associated with meal cost is due to two factors. As indicated by the volume variance computed in part a, $2,596 of the variance was due to higher than expec8-26 Chapter 8 Performance Evaluation ted attendance. The higher attendance was caused by Ms. Smith s decision to increase the invitation list to include former members. As indicated by the flexible budget variance computed in part b only $1,134 of the total variance was due to adding the dessert thereby increasing meal cost. The increase in the invitation list and the resultant increase in attendance also caused postage and facility costs to be over budget. In summary Ms. Smith is responsible for the $3,486 volume variance computed in part a, while Ms. McDougal is responsible for the $1,134 flexible budget variance computed in part b. These two variances combined equal the total variance of $4,620. Accordingly, Ms. Smith is responsible for a far greater portion of the total variance than is Ms. McDougal. d. The members of the organization are certainly concerned with the control of costs. The costs incurred by the organization are ultimately related to the dues charged to members. Not-for-profit entities are responsible for the effective utilization of resources. Accordingly, cost control is just as important to these organizations as it is to profit-oriented businesses. Exercise 8-1B Item to Classify Sale volume Sales price Materials cost Materials usage Labor cost Labor usage Fixed cost spending Fixed cost per unit (volume) Standard 38,000 units $6.90 per unit $2.10 per pound 102,400 pounds $8.25 per hour 56,980 hours $249,000 $2.51 per unit Actual 36,750 units $6.78 per unit $2.30 per pound 103,700 pounds $8.80 per hour 55,790 hours $244,000 $3.22 per unit Type of Variance Unfavorable Unfavorable Unfavorable Unfavorable Unfavorable Favorable Favorable Unfavorable Exercise 8-2B Item Budget Actual Variance F or U Sales revenue $620,000 $650,000 $30,000 F Cost of goods sold $450,000 $400,000 $50,000 F Material purchases at 10,000 pounds $260,000 $290,000 $30,000 U Materials usage $270,000 $260,000 $10,000 F Sales price $550 $560 $10 F 8-27 Chapter 8 Performance Evaluation Production volume Wages at 7,600 hours Labor usage Research and development expense Selling and administrative expenses 890 units 900 units 10 units $91,200 $90,800 $400 7,600 8,000 400 hours $81,000 $90,000 $9,000 $75,000 $71,000 $4,000 F F U U F Exercise 8-3B Sales Variable manufacturing Contribution margin Fixed manufacturing Fixed selling and admin. Net income Exercise 8-4B a. Master Price / Cost Budget per Unit 18,000 Units $12 $216,000 $8 (144,000) 72,000 (20,000) (18,000) $ 34,000 Master Budget 18,000 Units $216,000 (144,000) 72,000 (20,000) (18,000) $ 34,000 b. Flexible Budget 19,000 Units $228,000 (152,000) 76,000 (20,000) (18,000) $ 38,000 a. & b. Activity Variances $12,000 F 8,000 U 4,000 F 0 0 $ 4,000 F Sales manufacturing Variable Contribution margin Fixed manufacturing Fixed selling and admin. Net income Exercise 8-4B (continued) c. Flexible Budget 19,000 Units $228,000 (152,000) 76,000 (20,000) (18,000) $ 38,000 Since the per unit sales price and per unit variable manufacturing costs are the same for both the master and flexible budgets, the activity variances are solely attributable to the fact that sales volume was 1,000 units more than planned. The favorable $12,000 sales variance suggests that increased sales are beneficial. However, Irvin needs more information before drawing this conclusion. The increase in sales may have resulted from reducing the actual sales price which could produce negative consequences. The unfavorable $8,000 variable manufacturing cost variance is misleading. The 8-28 Chapter 8 Performance Evaluation total amount of variable cost is expected to increase when volume increases. This variance is expected and not a bad thing. Upperlevel marketing managers are normally responsible for the sales volume variances. d. The fixed costs in both the master and flexible budgets are estimates. Total fixed costs are assumed to be constant regardless of the volume of production and sales. Therefore, no variance between the master and flexible budgets is expected for fixed costs. Master Budget $20,000 18,000 $38,000 18,000 $2.11 Flexible Budget $20,000 18,000 $38,000 19,000 $2.00 e. Fixed manufacturing Fixed selling and admin. Total fixed cost (a) Units (b) Cost per unit (a b) The increase in sales volume reduces the fixed cost per unit, thereby increasing profitability. If the company uses a cost-plus pricing strategy, overstating cost per unit (underestimating volume) could result in overpricing the company s product. The company could lose market share to competitors who offer lower prices. 8-29 Chapter 8 Performance Evaluation Exercise 8-5B Flexible Budget 19,000 Units $228,000 (152,000) 76,000 (20,000) (18,000) $ 38,000 Actual Price / Cost at 19,000 Units $226,1001 (151,050)2 75,050 (21,000) (17,300) $ 36,750 a. & b. Flexible Budget Variances $1,900 U 950 F 950 U 1,000 U 700 F $1,250 U Sales Variable manufacturing Contribution margin Fixed manufacturing Fixed selling and admin. Net income 1 2 Actual sales: $11.90 x 19,000 units = $226,100 Actual variable cost: $7.95 x 19,000 units = $151,050 c. The unfavorable flexible budget sales variance results from actually selling products below the planned price. To properly interpret this result, Irvin must also consider the sales volume variance. As shown in Exercise 8-4B, the sales volume variance was $12,000 favorable. A rational explanation for the two variances is that management sought to increase sales volume by reducing the sales price. The strategy succeeded because the reduction in sales dollars caused by selling products at a lower price ($1,900 unfavorable flexible budget variance) was more than offset by the increase in sales volume ($12,000 favorable sales volume variance) and total contribution margin increased. The variable manufacturing cost variance ($950 favorable) is normally the responsibility of the purchasing agent or production supervisor. The variance suggests that either the purchasing agent paid less than planned or that employees used less than the planned amount of resources. The fixed manufacturing cost variance indicates that the company spent more than planned for those resources. The favorable fixed selling and administrative cost variance indicates that the company spent less than planned for those fixed costs. A variety of managers may be responsible for fixed cost variances. Exercise 8-6B a. Flexible Budget 8-30 Flexible Budget Flexible Budget Chapter 8 Performance Evaluation Sales ($40/hr) Variable cost ($25/hr) Contribution margin Fixed cost Net income b. 30,000 Hours $1,200,000 (750,000) 450,000 550,000 $ (100,000) 35,000 Hours $1,400,000 (875,000) 525,000 550,000 $ (25,000) 40,000 Hours $1,600,000 (1,000,000) 600,000 550,000 $ 50,000 The flexible budgets indicate that Escott will have to operate at the upper end of the estimated sales volume range in order to produce a profit. Therefore, the venture appears to be risky. However, the large amount of fixed cost (high operating leverage) indicates that significant profit potential exists for future years if Escott can increase the sales volume as the new office becomes well established. Exercise 8-7B a. Sales ($420 per roof) b. Master Budget 400 Roofs $168,000 Flexible Budget 450 Roofs $189,000 Sales Volume Variance $21,000 F Sales 1 Flexible Budget 450 Roofs $189,000 Actual Revenue for 450 Roofs $175,5001 Flexible Budget Variance $13,500 U Actual sales: $390 x 450 roofs = $175,500 c. Reducing the sales price increased revenues. The favorable sales volume variance is greater than the unfavorable flexible budget variance. The result is greater total sales than was planned. Exercise 8-8B Mr. Piedra s arguments are flawed. Since fixed costs are not affected by changes in the volume of activity, the unfavorable spending variance is unrelated to the favorable volume variance. Further, the scenario described in the problem suggests that the marketing director is responsible for the favorable volume variance. Mr. Piedra appears to be attempting to cover for his poor performance by claiming credit 8-31 Chapter 8 Performance Evaluation for the hard work and successful performance of the new marketing director. Exercise 8-9B The data in the problem suggest that employees can produce three units of software for each hour of labor (180,000 units / 60,000 hours = 3 units per hour). Employees should therefore have taken 70,000 labor hours (210,000 units / 3 units per hour) to complete the actual volume of software units. At the standard labor price, the production department should have incurred $1,330,000 (70,000 hours x $19 per hour) of labor cost. Since the actual labor cost was $1,323,000, the flexible budget labor variance is $7,000 favorable ($1,330,000 $1,323,000). The Vice President of Manufacturing should praise the production supervisor. Exercise 8-10B a. Materials usage variance = |Actual quantity Standard quantity| x Standard price |22,100 oz. (3,800 servings x 6 oz.)| x .20 = $140 F Possible explanations for the favorable usage variance include: (1) clerks used less than an average of 6 ounces of candy in each serving; (2) the sales clerks overcharged some customers (e.g., charged a customer for two servings and provided only one serving). b. 8-32 Chapter 8 Performance Evaluation Exercise 8-11B a. b. c. d. |Actual cost per unit Standard cost per unit | x Actual units |$0.80 $0.72| x 198,000 = $15,840 U |Actual price Standard price | x Actual quantity |$0.32 $0.30| x (2.5 x198,000) = $9,900 U |Actual quantity Standard quantity | x Standard price | (2.5 x 198,000) (2.4 x 198,000) | x $0.30 = $5,940 U Price variance Usage variance Total variance $ 9,900 Unfavorable 5,940 Unfavorable $15,840 Unfavorable Exercise 8-12B a. b. c. |Actual price Standard price | x Actual quantity |$0.40 $0.39| x (2.1 x 97,000) = $2,037 U |Actual quantity Standard quantity | x Standard price | (2.1 x 97,000) (2.0 x 97,000) | x $0.39 = $3,783 U Poor production scheduling could have forced the purchasing department to make hasty buying decisions without adequate time to shop for good prices, resulting in paying more than the standard cost for materials. Exercise 8-13B a. The personnel manager may have failed to do a thorough search for qualified employees who were willing to work for the standard labor price. The production manager may have scheduled work poorly thereby incurring overtime cost. Alternatively, poor scheduling could contribute to labor shortages, forcing the personnel manager to hire whatever labor was available on short notice. b. Exercise 8-14B 8-33 Chapter 8 Performance Evaluation a. Labor Variance Information Table Standard cost per lawn ($12 x 2 hours) Actual cost per lawn ($14 x 1.75 hours) Actual number of lawns serviced |Actual cost Standard cost| x Actual units |$24.50 $24.00| x 500 = $250 Unfavorable Amounts $24.00 $24.50 500 b. c. d. |Actual price Standard price| x Actual hours |$14 $12| x (1.75 x 500) = $1,750 Unfavorable |Actual hours Standard hours| x Standard price |(1.75 x 500) (2 x 500)| x $12 = $1,500 Favorable The unfavorable price variance could have been due to a failure to conduct a proper search for employees. It could also have been due to poor planning that resulted in overtime pay. Other explanations are possible. The favorable usage variance could be due to hiring better employees who worked harder than planned. The fact that employees were paid more than the standard labor price supports this explanation. Alternatively, the production supervisor could have motivated the employees to work harder than expected. Exercise 8-15B a. |Actual price Standard price| x Actual quantity = Price variance |$14.80 $15.00| x (125 x Act. labor hrs. used per treatment) = $15 125 x Actual labor hrs. used per treatment = 15 / .2 125 x Actual labor hrs. used per treatment = 75 Actual labor hrs. used per treatment = 75 / 125 Actual labor hrs. used per treatment = .6 Since the actual hours per treatment (.6) is greater than the standard hours (.5) the labor usage variance would be unfavorable. b. Exercise 8-16B a. |Actual cost Standard cost| x Actual hours |$9.50 $10.00| x 152,000 = $76,000 Favorable 8-34 Chapter 8 Performance Evaluation b. If particular variable overhead costs are significant companies may choose to isolate the variances associated with these particular costs. Analyzing specific variable overhead cost variances would require that a company establish multiple predetermined overhead rates, each relating to specific overhead costs, to overcome the interpretation problem inherent in using a single companywide rate. Exercise 8-17B a. Actual fixed overhead costs Budgeted overhead cost (19,000 x $135) Spending variance $2,750,000 2,565,000 $ 185,000 U The spending variance measures whether the actual amount spent on fixed cost was more or less than the planned amount. Many different managers could be responsible for the fixed cost spending variance. For example, upper management may be responsible for paying more than planned for rent on the manufacturing facility while the production manager may be responsible for paying more than planned for a supervisor s salary. b. Budgeted fixed overhead cost (19,000 x $135) Applied overhead (20,000 x $135) Volume variance $2,565,000 2,700,000 $ 135,000 F The favorable fixed overhead volume variance means that the company produced more products than planned, resulting in a lower than planned cost per unit. If the variance had been unfavorable, it would mean that the company produced fewer units of product than planned, resulting in a higher than planned cost per unit. 8-35 Chapter 8 Performance Evaluation Problem 8-18B a. & b. Number of units Per Unit Standards Sales revenue $25.96 Variable manufacturing costs Materials $9.00 Labor $2.60 Overhead $0.56 Variable G,S,&A $4.20 Contribution margin Fixed costs Manufacturing G,S,&A Net income c. & d. Number of units Per Unit Standards Sales revenue $25.96 Variable manufacturing costs Materials $9.00 Labor $2.60 Overhead $0.56 Variable G,S,&A $4.20 Contribution margin Fixed costs Manufacturing G,S,&A Net income Master Budget 200,000 $5,192,000 (1,800,000) (520,000) (112,000) (840,000) 1,920,000 (500,000) (360,000) $1,060,000 200,000 Master Budget $5,192,000 (1,800,000) (520,000) (112,000) (840,000) 1,920,000 (500,000) (360,000) $1,060,000 Flexible Budgets 180,000 220,000 $4,672,800 (1,620,000) (468,000) (100,800) (756,000) 1,728,000 (500,000) (360,000) $ 868,000 190,000 Flexible Budget $4,932,400 (1,710,000) (494,000) (106,400) (798,000) 1,824,000 (500,000) (360,000) $ 964,000 $5,711,200 (1,980,000) (572,000) (123,200) (924,000) 2,112,000 (500,000) (360,000) $1,252,000 Variances $259,600 U 90,000 26,000 5,600 42,000 96,000 F F F F U 0 0 $96,000 U e. The sales volume variances are useful in determining how changes in sales volume affect revenues and costs. Since the flexible budget is computed at standard prices and costs, the variances do not provide insight into differences between standard prices and costs and actual prices and costs. Problem 8-19B a. & b. 8-36 Chapter 8 Performance Evaluation Number of units 216,000 Flexible Budget Sales revenue $5,607,360 Variable manufacturing costs Materials (1,944,000) Labor (561,600) Overhead (120,960) Variable G,S,&A (907,200) Contribution margin 2,073,600 Fixed costs Manufacturing (500,000) G,S,&A (360,000) Net income $1,213,600 c. 216,000 Actual Results Variances $5,572,800 $34,560 U (1,900,800) (578,880) (120,960) (950,400) 2,021,760 (512,000) (356,000) $1,153,760 43,200 17,280 0 43,200 51,840 F U U U 12,000 U 4,000 F $59,840 U Upper-level marketing managers are responsible for the sales variance. These managers are normally responsible for establishing the sale price. In this case the actual sales price is less than the planned sales price, thereby causing an unfavorable flexible budget variance ($34,560). Mid-level production supervisors are normally responsible for the variable manufacturing cost variances. The favorable materials variance could have been caused by better usage efficiency or by paying less than the standard materials price. The unfavorable labor variance could have been caused by lower worker efficiency or by paying higher than the standard labor price. 8-37 Chapter 8 Performance Evaluation Problem 8-19B (continued) Many different managers may be responsible for fixed manufacturing cost variances. For example, a plant manager may be responsible for setting supervisory salaries while the chief executive officer may be responsible for determining the salary of the plant manager. In this case, the unfavorable variance could have been caused by higher than planned salary costs. Many different managers may be responsible for fixed selling and administrative costs. For example, a marketing manager may be responsible for advertising costs while the manager of the electronic data processing center may be responsible for purchases of computer equipment. The favorable variance could have been generated when a marketing manager paid less than the budgeted amount for advertising. Problem 8-20B Standard Costs per Can Sales revenue Variable costs: Materials cost Labor cost Overhead cost G, S, & A cost Contribution margin Fixed costs: Production G, S, & A cost Net income $1.05 $0.64 $0.10 $0.25 a. Master Budget $3.00 Price @ 600,000 Cans $1,800,000 (630,000) (384,000) (60,000) (150,000) 576,000 (215,000) (180,000) $ 181,000 b. Flexible Budget $2.70 Price @810,000 Cans $2,187,000 (850,500) (518,400) (81,000) (202,500) 534,600 (215,000) (180,000) $ 139,600 c. Flexible Budget $3.25 Price @400,000 Cans $1,300,000 (420,000) (256,000) (40,000) (100,000) 484,000 (215,000) (180,000) $ 89,000 d. Since the price of $3.00 per can generates the highest net income, this pricing strategy should be implemented. 8-38 Chapter 8 Performance Evaluation Problem 8-21B a. b. c. d. The flexible budget materials variances are computed on the basis of the actual quantity (i.e., 102,000 swimsuits). Actual price per yard = $1,653,600 636,000 = $2.60 Per yard Standard quantity = 6 yards x 102,000 Swimsuits = 612,000 yards Price variance = Actual price Standard price x Actual quantity Price variance $2.60 $2.50 x 636,000 = $63,600 Unfavorable Standard quantity Actual quantity x Standard price 612,000 636,000 x $2.50 = $60,000 Unfavorable e. Problem 8-22B a. Employees should be evaluated on the basis of the work they actually did rather than the work that was planned in the static budget. Accordingly, the labor variances should be based on the actual units made (i.e., 102,000 swimsuits). Labor Variance Information Table Standard price per hour Actual price per hour ($1,647,800 / 107,000 hours) Standard hours for flexible budget (1.0 Hrs. per swimsuit x 102,000 swimsuits) Actual hours used Amounts $15.00 $15.40 102,000 Hrs. 107,000 Hrs. b. c. d. Labor price variance = Standard price Actual price x Actual hours Labor price variance = $15 $15.40 x 107,000 = $42,800 Unfavorable Labor usage var. = Standard Hrs. Actual Hrs. x Standard price Labor usage var. = 102,000 Hrs. 107,000 Hrs. x $15.00 =$75,000 Unfavorable 8-39 Chapter 8 Performance Evaluation Problem 8-23B a. Predetermined overhead rate = Total expected overhead costs Total expected units Predetermined overhead rate = = $3 per unit $600,000 200,000 b. Spending variance = Actual overhead Budgeted overhead Spending variance = $592,000 $600,000 = $8,000 Favorable The variance is favorable because the actual fixed overhead costs were less than the standard overhead. c. Overhead volume variance = Budgeted overhead Applied overhead Overhead volume variance = $600,000 ($3 x 187,000) =$39,000 Unfavorable The variance is unfavorable because the company produced fewer units than planned, thereby increasing the fixed cost per unit. 8-40 Chapter 8 Performance Evaluation Problem 8-24B a. Materials Variance Information Table Standard price per pound Actual price per pound Standard quantity for flexible budget (2 pounds per unit x 10,800 units) Actual quantity used (1.9 pounds per unit x 10,800 units) Materials price variance: Actual price Standard price x Actual quantity = price variance $1.60 $1.50 x 20,520 pounds = $2,052 Unfavorable The variance is unfavorable because the actual price was higher than the standard price. Materials usage variance: Actual quantity Standard quantity x Standard price = Usage variance Amounts $1.50 $1.60 21,600 pounds 20,520 pounds b. 20,520 21,600 x $1.50 = $1,620 Favorable The variance is favorable because the actual quantity used was less than the standard quantity. c. Labor Variance Information Table Standard price per hour Actual price per hour Standard hours for flexible budget (0.5 hours per unit x 10,800 units) Actual hours used (0.6 hours per unit x 10,800 units) Labor price variance: Actual price Standard price x Actual hours = Price variance $8.00 $10.00 x 6,480 hours = $12,960 The variance is favorable because the actual price paid for labor was less than the standard price. Problem 8-24B (continued) Amounts $10.00 $8.00 5,400 hours 6,480 hours d. 8-41 Chapter 8 Performance Evaluation Labor usage variance: Actual hours Standard hours x Standard price= Usage variance 6,480 5,400 x $10.00 = $10,800 Unfavorable The variance is unfavorable because the actual hours used was more than the standard hours. e. Predetermined overhead rate = Total planned overhead costs Total expected units Predetermined overhead rate = = $1.20 per unit $12,000 10,000 f. Overhead spending variance = Actual overhead Budgeted overhead Overhead spending variance = $12,400 $12,000 Overhead spending variance = $400 Unfavorable The variance is unfavorable because the company spent more than it expected to spend. Overhead volume variance = Budgeted overhead Applied overhead Overhead volume variance = $12,000 ($1.20 x 10,800) Overhead volume variance = $960 Favorable The variance is favorable because the company produced more units than planned, thereby reducing the fixed cost per unit. g. Problem 8-25B a. Materials Variance Information Table Standard price per Square Foot Amounts $0.25 8-42 Chapter 8 Performance Evaluation Actual price per Square Foot Standard quantity for flexible budget (1 Square Foot per unit x 208,000 units) Actual quantity used b. Materials price variance: $0.24 208,000 Square Feet 230,000 Square Feet Actual price Standard price x Actual quantity = Price variance $0.24 $0.25 x 208,000 Square Feet = $2,080 Favorable The variance is favorable because the actual price was less than the standard price. Materials usage variance: Actual quantity Standard quantity x Standard price = Usage var. 230,000 208,000 x $0.25 = $5,500 Unfavorable The variance is unfavorable because the actual quantity is more than the standard quantity. c. Labor Variance Information Table Standard price per hour Actual price per hour Standard hours for flexible budget (0.2 hours per unit x 208,000 units) Actual hours used Labor price variance: Actual price Standard price x Actual hours =Price variance $6.90 $7.00 x 39,600 Hours = $3,960 Favorable The variance is favorable because the actual price paid was less than the standard price. Amounts $7.00 $6.90 41,600 hours 39,600 hours d. Problem 8-25B (continued) Labor usage variance: Actual hours Standard hours x Standard price = Usage variance 39,600 41,600 x $7.00 = $14,000 Favorable 8-43 Chapter 8 Performance Evaluation The variance is favorable because the actual hours were less than the standard hours. e. Predetermined overhead Rate = Total planned overhead costs Total expected units = $0.50 per unit Predetermined overhead Rate = f. $200,000 400,000 Spending variance = Actual overhead Budgeted overhead Spending variance = $102,000 $100,000 = $2,000 Unfavorable The variance is unfavorable because actual fixed overhead costs were more than the budgeted overhead. Overhead volume variance = Budgeted overhead Applied overhead Overhead volume variance = $100,000 ($0.50 x 208,000) =$4,000 Favorable The variance is favorable because the company produced more units than planned, thereby reducing the fixed cost per unit. g. Actual costs will appear on the company s income statement. Accordingly, the amount of gross margin is computed as follows: Sales Cost of goods sold: Cost of materials ($0.24 x 230,000) Cost of labor ($6.90 x 39,600) Cost of overhead Gross margin $707,200 (55,200) (273,240) (102,000) $276,760 Problem 8-26B a. |SQ AQ| x SP = Usage variance SQ = 2.50 x 8,000 = 20,000 pounds |20,000 AQ| x $2.00 = $400 favorable |20,000 AQ| = 200 8-44 Chapter 8 Performance Evaluation Since the variance is favorable, the actual quantity used must be less than the standard quantity. AQ = 19,800 pounds b. |SP AP| x AQ = Price variance |$2.00 AP| x 19,800 = $792 favorable |$2.00 AP| = $0.04 Since the variance is favorable, the actual price must be less than the standard price. AP = $1.96 c. |SHrs AHrs| x SP = Usage variance SHrs = 0.60 x 8,000 = 4,800 hours |4,800 AHrs| x $12 = $960 unfavorable |4,800 AHrs| = 80 Since the variance is unfavorable, the actual labor hours used must be more than the standard hours. AHrs = 4,880 d. |SP AP| x AHrs = Price variance |$12.00 AP| x 4,880 = $1,952 Unfavorable |$12.00 AP| = $0.40 Since the variance is unfavorable, the actual price must be greater than the standard price. AP = $12.40 Problem 8-27B a. and b. Cost Computation = Standard Cost per Wheel 8-45 Chapter 8 Performance Evaluation Direct material Direct labor Overhead Total per wheel c. and d. Cost Direct material Direct labor Overhead Total per wheel e. COST Direct material: Price var. Usage var. Direct labor Price var. Usage var. 2 lbs. per unit x $5.50 per lb. 2.5 hours per unit x $8.00 per hour $168,000/12,000 $11.00 $20.00 $14.00 $45.00 Computation $175,500/14,400 actual units 2.2 hrs./unit x $8.40/hr. = $180,000/14,400 Actual = Cost per Wheel $12.19 $18.48 $12.50 $43.17 COMPUTATION ($5.50/lb - $5.85*/lb) x 30,000 lbs. *$175,500 30,000 lbs = $5.85/lb (28,800 lbs* - 30,000 lbs) $5.5/lb *2 lbs/ unit x 14,400 actual units ($8/hr - $8.40/hr) x 31,680 hrs* *2.2 hrs/unit x 14,400 actual units (36,000 hrs* 31,680 hrs.) x $8/hr *2.5 hrs/unit x 14,400 actual units VARIANCE $10,500 (U) $ 6,600 (U) $12,672 (U) $34,560 (F) Problem 8-27B (continued) All the variances need consideration for investigation. Management selects variances for investigation based on materiality, frequency, capacity to control, and susceptibility to management abuse. The favorable labor usage variance may have been the result of using a more experienced and costly work force resulting in the unfavorable labor price variance. Other causes may have been effective planning to reduce labor waste, high morale, or superior supervision. 8-46 Chapter 8 Performance Evaluation f. FIXED OH COST Spending var. Volume var. COMPUTATION $168,000 bud. OH $180,000 actual OH $168,000 M. bud. $201,600 applied OH* *$168,000/12,000 = $14 std cost per unit $14 x 14,400 actual units = $201,600 VARIANCE $12,000 (U) $33,600(F) The unfavorable spending variance indicates that more was spent for fixed overhead than was budgeted or planned. The favorable volume variance occurred because more units were produced than planned. Therefore, the cost per unit for fixed overhead was less than planned (operating leverage). The volume variance is a capacity utilization measure. Since costs are fixed, the more units produced the more profit can be made (economies of scale). 8-47 Chapter 8 Performance Evaluation Problem 8-28B a. Master Budget Expenses: Variable expenses Refreshments Postage Step expenses Printing Facility Fixed expenses Dinner Gift Publicity Total $ 375 (1) 312 (2) 500 250 200 100 50 $1,787 Flexible Budget $ 450 (3) 351 (4) 550 (5) 350 (6) 200 100 50 $2,051 = Variance $ (75) (39) (50) (100) 0 0 0 $(264) (1) 375 attendees x $1 charge = $375 (2) 800 mailings @ $.39 = $312. (3) 450 attendees x $1 charge = $450 (4) 900 mailings @ $.39 = $351 (5) $500 for 800 invitations + $50 for an additional 100. (6) Since original room capacity was 400, attendance of 450 necessitated the next larger room that cost $350. The volume variances indicate that the department incurred $264.00 more cost than planned because more people than planned attended the presentation. You would expect unfavorable variances for variable costs and step costs. Since more people are attending, total variable and step costs will increase. Fixed costs are planned to stay constant since they are not affected by volume. Accordingly, there are no fixed cost variances. Problem 8-28B (continued) b. 8-48 Chapter 8 Performance Evaluation Flexible Budget Expenses: Variable expenses Refreshments Postage Step expenses Printing Facility Fixed expenses Dinner Gift Publicity Total $ 450 351 550 350 200 100 50 $2,051 Actual Results $ 450 3510 550 350 230 100 75 $2,106 = Variances 0 0 0 0 ($30) 0 (25) ($55) The refreshment, postage, facility, and printing variances are no longer unfavorable. There are no variances for these costs since the actual and budgeted costs per unit or per step are the same and both budgets are based on the actual number of attendees (i.e. 450). However, the flexible budget fixed cost variances for the dinner and publicity represent spending variances. These variances are not related to volume. In other words, even though the budget and actual volume are the same, the department spent more on the dinner and for publicity than was planned. 8-49 Chapter 8 Performance Evaluation Problem 8-28B (continued) c. Budgeted fixed cost per unit: $350/375 = $0.933 Actual fixed cost per unit: $405*/450 = $0.900 *$230 + $100 + $75 = $405 The difference in the two amounts is meaningless from a pricing perspective because the department is a not-for-profit entity that is not charging participants for the lecture. Even so, the fact that fixed cost per unit is lower than planned is an indication that the department has been more effective in providing service to the community. Specifically, insights of the speaker were disseminated to a wider audience at the same fixed cost. Accordingly, the cost of dissemination per participant is lower. d. The department has a limited supply of funds at its disposal. If too much money is spent on the DVL, there will be less money available for other expenditures such as faculty travel, supplies, equipment purchases, scholarships. Controlling cost is important to not-forprofit entities the same as it is for profit-oriented businesses. 8-50 Chapter 8 Performance Evaluation ATC 8-1 a. The increase in sales volume was not achieved by lowering the sales price. The budgeted sales price was $15 per unit (i.e., $3,750,000 250,000 units). The actual sales price was $15.1923 per unit (i.e., $3,950,000 260,000 units). Some other factor such as increased advertising or a general rise in demand due to a robust economy caused the increase in sales. There is a problem with the performance evaluation system. Performance evaluation should be based on flexible budget variances rather than the activity variances. To prepare a flexible budget, first determine the budgeted sales price, and the standard cost per unit for materials, labor, overhead, and G,S,&A. These amounts are shown below: Dollars $3,750,000 600,000 312,500 337,500 475,000 Units 250,000 250,000 250,000 250,000 250,000 Cost per Unit $15.00 $2.40 $1.25 $1.35 $1.90 b. c. Sales Price Materials Labor Overhead G,S, and A = = = = = 8-51 Chapter 8 Performance Evaluation ATC 8-1 (continued) The flexible budget variances are shown below. Actual Results Variances 260,00 0 260,000 0 $3,900,000 $3,950,000 $50,000 Favorable 1,800 4,000 3,700 7,300 44,800 Favorable Favorable Unfavorable Unfavorable Favorable Flexible Budget Number of Units Sales Revenue Variable Manuf. Costs Materials ($2.40/unit) (624,000) (622,200) Labor ($1.25/unit) (325,000) (321,000) Overhead ($1.35/unit) (351,000) (354,700) Variable G,S,&A ($1.90/unit) (494,000) (501,300) Contribution Margin ($8.10/unit) 2,106,000 2,150,800 Fixed Costs Manufacturing (1,275,000) (1,273,100) G,S,&A (470,000) (479,300) Net Income $ 361,000 $ 398,400 1,900 Favorable 9,300 Unfavorable $ 37,400 Favorable d. A cost is defined as fixed if it does not change when there is a change in activity, but there are other things that can cause a fixed cost to change. For example, the monthly rental rate charged by a landlord can be increased, or the property tax rate charged by a municipality can be raised or lowered. Scenario 1: The favorable price variance may have been attained by purchasing low-quality materials. This could have led to waste in the production process that was beyond Mr. Delo s control. Scenario 2: Mr. Delo could have failed to properly supervise the workers under his control. The workers could have developed poor work habits that led to unnecessary waste of materials. e. 8-52 Chapter 8 Performance Evaluation ATC 8-1 (continued) f. Recall that the total variance is composed of price and usage variances. Note that the total labor variance was favorable (see part c above). Accordingly, if the labor price variance was unfavorable, the usage variance had to be favorable; otherwise the total could not have been favorable. The fixed overhead volume variance was favorable, because more units were produced than were budgeted (260,000 vs. 250,000). g. 8-53 Chapter 8 Performance Evaluation ATC 8-2 a. Task 1 Materials variances Total variance |Actual cost Standard cost| x Actual units |$44.10 $40.00| x 82,000 = $336,200 Unfavorable Price variance |Actual price Standard price| x Actual quantity |$2.10 $2.00| x (21 x 82,000) = $172,200 Unfavorable Usage variance |Actual quantity Standard quantity| x Standard price | (21 x 82,000) (20 x 82,000) | x $2.00 = $164,000 Unfavorable The unfavorable price variance indicates that the KTI paid more than planned for the planks of wood. The party responsible for the price variance is the purchasing agent. The purchasing agent could have been careless (i.e., the failure to shop around, to obtain quantity discounts, or to buy the right quality of lumber). The variance could have been due to factors beyond the purchasing agent s control (e.g., inflation, lumber shortage). The unfavorable usage variance indicates that KTI used more materials than should have been used to make 82,000 tables. The responsible party is the production supervisor. The variance could be due to factors within control of the production supervisor. Examples include failure to motivate workers, or failure to physically control inventory thereby permitting inventory to be lost, damaged, or stolen. The factors could be beyond the control of the supervisor. For example, the quality of the wood could be poor, resulting in waste. 8-54 Chapter 8 Performance Evaluation ATC 8-2 (continued) a. Task 2 Labor variances Total variance |Actual cost Standard cost| x Actual units |$26.10 $25.50| x 82,000 = $49,200 Unfavorable Price variance |Actual price Standard price| x Actual quantity |$9.00 $8.50| x (2.9 x 82,000) = $118,900 Unfavorable Usage variance |Actual quantity Standard quantity | x Standard price | (2.9 x 82,000) (3 x 82,000) | x $8.50 = $69,700 Favorable The unfavorable price variance indicates that KTI paid more for labor than the company planned to pay. The responsible party could be the personnel manager or the production supervisor. The personnel manager could have agreed to pay a higher wage. The production supervisor could have authorized overtime pay. The cause could be beyond anyone s control. For example, the government may have raised the minimum wage. The favorable usage variance indicated that KTI used less labor than was planned in order to make 82,000 tables. The responsible party could have been the personnel manager or the production supervisor. The personnel manager could have hired more competent employees. The production manager could have engaged in practices that highly motivated employees. a. Task 3 Fixed overhead variances Spending variance: |Actual fixed cost Budgeted fixed cost| |$1,328,400 $1,280,000| = $48,400 Unfavorable Volume variance: Applied overhead Budgeted fixed cost |$1,312,000* $1,280,000| = $32,000 Favorable *Predetermined overhead rate = $1,280,000 80,000 = $16 per Table $16 per table x 82,000 tables = $1,312,000 ATC 8-2 (continued) 8-55 Chapter 8 Performance Evaluation The unfavorable spending variance indicates that the company paid more than planned for fixed cost. The responsible party is difficult to identify because the cost(s) that increased are not known. Rent on the manufacturing equipment could be the responsibility of the plant manager. Salaries paid to supervisors could be the responsibility of the personnel manager. More detail would be required to identify the specific cause of the variance and the responsible party. The favorable volume variance indicates that KTI made and sold more units than planned, which reduced the fixed cost per unit. b. Materials price variance Materials usage variance Labor price variance Labor usage variance Fixed cost spending variance Total c. $172,200 164,000 118,900 69,700 48,400 $433,800 Unfavorable Unfavorable Unfavorable Favorable Unfavorable Unfavorable She should encourage a fair and impartial investigation as to the cause and responsible parties. Sometimes just knowing that performance is being monitored will be sufficient to motivate the necessary improvement. Heavy-handed tactics are likely to fail and lead to gamesmanship such as budget slack or lowballing. Only in cases of consistent incompetence or intentional disregard should disciplinary action be taken. 8-56 Chapter 8 Performance Evaluation ATC 8-3 a. b. The measurement used is number of errors per 100 lines of code. Some of the benefits of using CMM and TSP are: (1) faster life-cycle development of new programs, (2) more flexibility when choosing between developing a software or hardware solution to solve a product development problem, and (3) better program security since much of the vulnerability of computer programs comes from coding errors. c. d. India and China. Students will probably report the data shown in the first table, but the May 16, 2005 issue of Business Week published revised data that are shown in the second table. Error rates per 1000 lines of code during program development Error rates per 1000 lines of code for completed programs Without TSP With TSP 100 0.06 0.2 to 1.2 0.0 to 0.06 Revised data from the May 16, 2005 Business Week: Without TSP With TSP 120 50 0.0 to 0.1 Error rates per 1000 lines of code during program development Error rates per 1000 lines of code for completed programs 1.05 to 7.5 ATC 8-4 8-57 Chapter 8 Performance Evaluation a. Kemp s standard costing system is motivating inefficiencies rather than controlling costs. Managers are probably injecting budget slack (i.e., overstating planned costs) to ensure that they are able to escape the negative consequences of failing to attain standards. The problem lies in Mr. Quayle s managerial style. He has created an adversarial relationship with his employees. They are forced to engage in unscrupulous activities (e.g., lying, budget slack) in order to avoid chastisement or dismissal. The sense of mistrust is probably too severe to remedy. Mr. Quayle should be asked to resign. b. ATC 8-5 a. b. The budget game Lovelady is playing is commonly called lowballing. Lovelady s behavior is unethical. However, the description in the case suggests that she is not an accountant. Accordingly, Lovelady is not bound by the code of ethics set by the Institute of Management Accountants. An informed manager should participate with Lovelady in the budgeting process. Employees should not be given free rein in the budgeting process. c. 8-58 Chapter 8 Performance Evaluation ATC 8-6 Screen capture of cell values: 8-59 Chapter 8 Performance Evaluation ATC 8-6 (continued) Screen capture of cell formulas: 8-60 Chapter 8 Performance Evaluation ATC 8-6 (continued) Screen capture of cell formulas (continued): 8-61 Chapter 8 Performance Evaluation ATC 8-7 Screen capture of cell values: 8-62 Chapter 8 Performance Evaluation ATC 8-7 Screen capture of cell formulas: 8-63 Chapter 8 Performance Evaluation ATC 8-7 (continued) 8-64 Chapter 8 Performance Evaluation Chapter 8 Comprehensive Problem Requirement a Number of units Sales revenue Cost per Unit $120 40 25 4 6 Static Budget 5,000 $600,000 (200,000) (125,000) (20,000) (30,000) 225,000 (50,000) (60,000) (71,950) (12,000) $ 31,050 Flexible Budgets 3,000 $360,000 (120,000) (75,000) (12,000) (18,000) 135,000 (50,000) (60,000) (71,950) (12,000) $ (58,950) 6,000 $720,000 (240,000) (150,000) (24,000) (36,000) 270,000 (50,000) (60,000) (71,950) (12,000) $ 76,050 Variable manufacturing costs Materials Labor Overhead Variable G,S,&A Contribution margin Fixed costs Manufacturing rent Dep. on manu. equip. G,S,&A Expenses Dep. On admin. equip. Net income Requirements b & c Number of units Sales revenue Static Budget 5,000 Cost per Unit $120 40 25 4 6 $ 600,000 (200,000) (125,000) (20,000) (30,000) 225,000 (50,000) (60,000) (71,950) (12,000) $ 31,050 Flexible Budget Variance 6,000 $720,000 (240,000) (150,000) (24,000) (36,000) 270,000 $120,000 (40,000) (25,000) (4,000) (6,000) 45,000 Favorable Unfavorable Unfavorable Unfavorable Unfavorable Favorable Variable manufacturing costs Materials Labor Overhead Variable G,S,&A Contribution margin Fixed costs Manufacturing rent Dep. on manu. equip. G,S,&A Expenses Dep. on admin. equip. Net income (50,000) 0 (60,000) 0 (71,950) 0 (12,000) 0 $ 76,050 $ 45,000 Favorable 8-65

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