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3310 - Chapter 16 Fundamentals of Variance Analysis

3310 - Chapter 16

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3310 - Chapter 16. Fundamentals of Variance Analysis. The Use of Variances. Difference between actual and budget is called a VARIANCE. For costs: Variances are FAVORABLE if Actual < Budget for costs Variances are UNFAVORABLE if Actual > Budget for costs - PowerPoint PPT Presentation

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Page 1: 3310 - Chapter 16

3310 - Chapter 16

Fundamentals of Variance Analysis

Page 2: 3310 - Chapter 16

The Use of Variances

• Difference between actual and budget is called a VARIANCE.

• For costs:– Variances are FAVORABLE if Actual < Budget for

costs– Variances are UNFAVORABLE if Actual > Budget for

costs

• For revenues, the opposite holds true.– FAVORABLE: Actual > Budget– UNFAVORABLE: Actual < Budget

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Static Budgets and Static-Budget Variances

• Budget serves as a guideline

• Budget must be “flexible”– Static budget - budget prepared for one level

• Budget prepared for 1,000 units

• Costs $10,000 + $5 x

• Budgeted Cost = ?

• Suppose actual units prepared 900 units costing $14,700

• Did we beat budget?

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Flexible Budgets

• We did beat the static budget but that amount is really meaningless because we produced less units than the static budget

• Flexible budget prepared for several levels– A new budget must be produced for actual units

produced– 900 units x $5 = 4,500 + 10,000 = $14,500– Budget = $14,500, Actual = $14,700– We are over budget by $200.

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Flexible Budget for Several Levels900 units 1000

units1100 units

Variable Costs

$5 unit 4,500 5,000 5,500

Fixed costs

10,000 10,000 10,000

Total costs

14,500 15,000 15,500

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Variances

• Static budget variances– Difference in actual and budgeted amounts– Can be broken down into many more detailed

variances• Sales activity variance

– difference in flexible budget sales and static budget sales (what we should have brought in for the units actually sold and what we should have brought in for the units we budgeted to sell)

• Profit variances– difference in actual and flexible budget amounts

– Broken down into price and efficiency variances

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Profit Variances

• Sales price variance– Difference in actual price and budgeted sales price

• Variable production cost variances – Difference in actual variable cost and budgeted variable cost

• Fixed production cost variance– Difference in actual fixed costs incurred and budgeted

amounts• Marketing and administrative variances

– Difference in actual marketing and admin. Costs and budgeted amounts

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Standard Cost Systems

• Benchmark or norm used for planning and control purposes; a model or budget against which actual results are compared and evaluated.

• Comparable to a budget broken down to a unit figure

• Like predetermined OH rates

• Developed for DM, DL, and OH

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Standard Cost SystemsBenefits

• Easier bookkeeping

• Motivation

• Planning

• Control costs

• Decision making

• Performance evaluation

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Standard Cost Systems

• Who develops standard costs?– Engineers

– Cost accountants

– Managers

– Workers

• Types of standards– Expected standards

– Practical standards

– Ideal standards

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Standard costs

• Developed for DM, DL, and OH (both variable and fixed)

• Each category involves a price and quantity element

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Direct Material Variances

• Price Variance

• Efficiency (Quantity) Variance

• Causes

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Direct Material Variances

• AP x AQ SP x AQ SP x SQ

• |__________________| |_____________|

• Price Variance Efficiency Variance

• |_________________________________|

• Total Materials Variance

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Standard Quantity Allowed

• Standard Quantity per unit

• X units produced

• = Standard Quantity Allowed

• Example:

• 4 yards per sleeping bag

• X 100 bags produced

• = 400 yards of fabric allowed

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Direct Labor Variances

• Price (Rate) Variance - difference in rates actually paid and standard wage rates per hour

• Efficiency Variance - difference in actual hours worked and standard hours that should have been worked.

• Causes

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Direct Labor Variances

• AR x AH SR x AH SR x SH

• |__________________| |_____________|

• Rate Variance Efficiency Variance

• |_________________________________|

• Total Labor Variance

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Responsibility for Variances

• Materials price - Purchasing

• Materials quantity - Production, Purchasing

• Labor rate - Personnel, Production

• Labor efficiency - Production, Purchasing

• BUT:

• Must investigate the variance to see who is actually responsible

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Overhead Variances

• The standard price for the overhead is determined by the predetermined overhead rate.

• This rate is separated for variable and fixed overhead.

• The rate is determined by choosing a level, the “denominator” level, at which a company thinks it will produce.

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Predetermined OH Rates

• Variable OH: $4,500/900 = $5

• $5,000/1,000 = $5

• $5,500/1,100 = $5

• It makes no difference which level of output we choose to set the variable OH rate. It is $5 for all of the levels.

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Predetermined OH Rates

• Fixed OH: $10,000/900 = $11.11

• $10,000/1,000 = $10

• $10,000/1,100 = $9.09• It DOES make a difference which level of output we

choose to set the fixed OH rate. The OH rate varies from $11.11 to $9.09 based on the level of units we choose to set the rate. This chosen level is called the DENOMINATOR LEVEL.

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Predetermined OH Rates

• If we choose to use 900 units to set our OH rate, we will have the higher $11.11 OH rate.

• More overhead will be allocated than the other two levels.

• We are more likely to have overapplied OH with a higher rate.

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Variable Overhead

• Profit variances– Price variance

• Difference in actual cost and predetermined variable overhead rate multiplied by the actual cost driver

– Efficiency variance

• Difference in actual cost driver and budgeted cost driver multiplied by the predetermined variable overhead rate

• Causes

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Fixed Overhead

• Flexible budget rates - based on denominator level

• Profit variance – termed price variance– Difference in actual amount spent and budgeted

amount– Controllable variance

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Fixed Overhead

• Production-volume variance– Difference in flexible budget and

predetermined fixed overhead rate x standard activity

– Depends on denominator level chosen– This is part of the sales activity variance– Deemed an “uncontrollable” variance

• Causes

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Journal Entries

• Standard costs debited to Inventories and COGS

• Unfavorable Variances - debited (more costs)

• Favorable Variances - credited (less costs)

• Actual costs credited

• At end of period, variances are usually closed into cost of goods sold

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Closing Journal Entry

• Debit Variable Overhead Applied (standard price x standard activity for actual output) to close

• Debit (credit) unfavorable (favorable) Variable OH Price Variance

• Debit (credit) unfavorable (favorable)Variable OH Efficiency Variance

• Credit Variable Overhead (Actual) for actual overhead costs incurred (to close)

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Closing Journal Entry

• Debit Fixed Overhead Applied (standard price x standard activity for actual output) to close

• Debit (credit) unfavorable (favorable) Fixed OH Price Variance

• Debit (credit) unfavorable (favorable) Fixed OH Production Volume Variance

• Credit Fixed Overhead (actual) for actual overhead costs incurred (to close)

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Management Uses of Variances

• Management by Exception

• Performance Measurement– Effectiveness– Efficiency

• Continuous Improvement

• Financial and Nonfinancial Performance Measures

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Other Topics

• Benchmarking and variance analysis– Benchmark is a quantity from an outside company– Benchmarks often represent “best practices”– Efficient use of hours, material, prices, etc.– Set up the benchmark as your standard