Fundamental Managerial Accounting Concepts Thomas P. Edmonds Bor-Yi Tsay Philip R. Olds Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights

Fundamental Managerial Accounting ConceptsThomas P. Edmonds

Bor-Yi Tsay

Philip R. Olds

Copyright © Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.2009 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinMcGraw-Hill/Irwin

Fifth Edition

©The McGraw-Hill Companies, Inc. 2006McGraw-Hill/Irwin

Chapter Eight

Performance Evaluation

F = Favorable varianceActual sales exceeded

budgeted level of sales.

Preparing Flexible Budgets


Would you expect thesevariances to be favorable

or unfavorable giventhe favorable sales

variance?



The relevant question is . . .

“What portion of the variances is due to activity and price changes, and whatportion is due to cost control?”

To answer the question, we must

the budget for the

actual activity.

Preparing Flexible BudgetsMelrose Manufacturing, a producer of small high-quality trophies, plans to make and sell 18,000 trophies during 2006. Melrose uses a standard

cost system as outlined below:

Preparing Flexible BudgetsFrom the standard cost information, Melrose

prepares the following static and flexible budgets.

18,000 18,000 × $80 = × $80 = $1,440,000$1,440,000

18,000 18,000 × $80 = × $80 = $1,440,000$1,440,000

Central Concept

If you can tell me what your activity wasfor the period, I will tell you what your costs and revenue should have been.


Determining Variances for Performance Evaluation

The differences between standard and The differences between standard and actual amounts are called variances. A actual amounts are called variances. A

variance may bevariance may be favorablefavorable or or unfavorableunfavorable. When actual sales . When actual sales are less are less

thanthan expected sales, an expected sales, an unfavorable unfavorable sales variancesales variance exists. When actual costs exists. When actual costs

are are more than standardmore than standard costs, an costs, an unfavorable cost varianceunfavorable cost variance exists. exists.

The differences between standard and The differences between standard and actual amounts are called variances. A actual amounts are called variances. A

variance may bevariance may be favorablefavorable or or unfavorableunfavorable. When actual sales . When actual sales are less are less

thanthan expected sales, an expected sales, an unfavorable unfavorable sales variancesales variance exists. When actual costs exists. When actual costs

are are more than standardmore than standard costs, an costs, an unfavorable cost varianceunfavorable cost variance exists. exists.and visa

versa

Sales Volume VariancesThe difference between the static budget sales amount and the flexible budget sales amount is

a measure of the sales volume variance.

Interpreting the Volume Variances

In the case of Melrose, the marketing manager (who is usually responsible for the volume

variance) exceeded planned sales volume by 1,000 units, resulting in an $80,000 favorable

revenue variance ($80 × 1,000). The unfavorable cost variances are somewhat misleading. Melrose incurred higher costs because it manufactured and sold more

units than planned.

Interpreting the Volume VariancesBecause actual volume is not known until the end of the period, the selling price must be based on

planned volume. At the planned volume of 18,000 units, Melrose’s fixed cost per unit is expected to

be as follows:Fixed costs: Manufacturing cost 201,600$ General, selling, and administrative cost 90,000 Total fixed costs 291,600$ Divided by planned level of activity ÷ 18,000 Fixed cost per unit 16.20$

Fixed costs: Manufacturing cost 201,600$ General, selling, and administrative cost 90,000 Total fixed costs 291,600$ Divided by planned level of activity ÷ 18,000 Fixed cost per unit 16.20$

Based on actual volume, fixed cost per unit Based on actual volume, fixed cost per unit would be $15.35 ($291,600 ÷ 19,000).would be $15.35 ($291,600 ÷ 19,000).

Flexible Budget VariancesNow we are comparing actual results achieved

with the results that should have been achieved at that actual activity level.

$78 $78 × 19,000 = × 19,000 = $1,482,000$1,482,000$78 $78 × 19,000 = × 19,000 = $1,482,000$1,482,000

Calculating Sales Price Variance

Actual sales (19,000 × $78) 1,482,000$ Expected sales (18,000 × $80) 1,440,000

Favorable total sales variance 42,000$

Activity variance (volume) 80,000$ Sales price variance (38,000) Favorable total sales variance 42,000$

oror

Establishing StandardsA standard represents the amount a price,

cost, or quantity should be, based on certain anticipated circumstances. Accountants,

engineers, purchasingagents, and production managers combine

efforts to set standards that encourage efficient future production.

Establishing StandardsShould we use

ideal standardsideal standards that represents what costsshould be under thebest circumstances?

EngineerManagerialAccountant

I recommend using practical practical standardsstandards that an average

worker performing diligentlywould be able to achieve.

Establishing StandardsLax standards

createmotivationalproblems.

Production Manager

HumanResourceManager

I agree. Ideal standardsbased on perfection, are

unattainable and discouragemost employees

Need for Standard Costs

Standard costs help managers plan and establish benchmarks against which actual performance can be judged. Management by exceptionManagement by exception focuses on material

differences between actual and expected results.

Standard costs help managers plan and establish benchmarks against which actual performance can be judged. Management by exceptionManagement by exception focuses on material

differences between actual and expected results.

Selecting Variances to InvestigateManagement by exception tells us to consider:Management by exception tells us to consider:

1.1. the materiality of a variance,the materiality of a variance,

2.2. how frequently it occurs,how frequently it occurs,

3.3. the capacity to control the variance, andthe capacity to control the variance, and

4.4. the characteristics of the items behind the variance.the characteristics of the items behind the variance.

Management by exception tells us to consider:Management by exception tells us to consider:

1.1. the materiality of a variance,the materiality of a variance,

2.2. how frequently it occurs,how frequently it occurs,

3.3. the capacity to control the variance, andthe capacity to control the variance, and

4.4. the characteristics of the items behind the variance.the characteristics of the items behind the variance.

Flexible Budget Variances

FlexibleBudget

ActualResults

BudgetVariances

Number of units 1,000 1,000 - Sales Revenue 5,000$ 5,000$ -$ Variable Manuf Costs

Materials 6,000 6,630 (630) UnfavorableLabor 9,000 9,610 (610) Unfavorable

Hanson, Inc.

Recall: we are comparing actual results achieved with the results that should have been achieved at the

activity level.

Price and Usage Variances

Price Variance

Standard Cost Variances

The difference betweenthe actual price and the

standard price

Usage Variance

The difference betweenthe actual quantity andthe standard quantity

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price

Price Variance Usage Variance

Standard price is the amount that should have been paid for the resources acquired.




Standard quantity is the quantity that shouldhave been used for the output achieved.


AQ AP - SP SP AQ - SQ

AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity

AQ AP - SP SP AQ - SQ

AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity




Hanson Inc. has the following material standards to manufacture one Zippy:

1.5 pounds per Zippy at $4.00 per pound

Last week 1,700 pounds of material were purchased and used to make 1,000 Zippies.

The material cost a total of $6,630.

Calculating the Materials Priceand Usage Variances Zippy

Price variance$170 favorable

Usage variance$800 unfavorable

1,700 lbs. 1,700 lbs. 1,500 lbs. × × × $3.90 per lb. $4.00 per lb. $4.00 per lb.

= $6,630 = $ 6,800 = $6,000


Material Variances Summary

Zippy

Total Variance$630 Unfavorable$630 Unfavorable

Materials Price VarianceMaterials Quantity Variance

Production Manager Purchasing Manager

The standard price is used to compute the quantity varianceThe standard price is used to compute the quantity varianceso that the production manager is not held responsible forso that the production manager is not held responsible for

the purchasing manager’s performance.the purchasing manager’s performance.

The standard price is used to compute the quantity varianceThe standard price is used to compute the quantity varianceso that the production manager is not held responsible forso that the production manager is not held responsible for

the purchasing manager’s performance.the purchasing manager’s performance.

Responsibility for Materials Variances

Responsibility for Materials Variances

I am not responsible forI am not responsible for this unfavorable material this unfavorable material

quantity variance.quantity variance.

You purchased inferiorYou purchased inferiormaterial, so my peoplematerial, so my peoplehad to use more of it.had to use more of it.

Production Manager

Your poor scheduling Your poor scheduling sometimes requires me to sometimes requires me to

rush order material at a rush order material at a higher price, causing higher price, causing

unfavorable price variances. unfavorable price variances.

Purchasing Manager

Flexible Budget Variances

FlexibleBudget

ActualResults

BudgetVariances

Number of units 1,000 1,000 - Sales Revenue 5,000$ 5,000$ -$ Variable Manuf Costs

Materials 6,000 6,630 (630) UnfavorableLabor 9,000 9,610 (610) Unfavorable

Hanson Inc.

Recall: we are comparing actual results achieved with the results that should have been achieved at the

activity level.

AH AP – SP SP AH – SH

AH = Actual Hours SP = Standard Price AP = Actual Price SH = Standard Hours

AH AP – SP SP AH – SH

AH = Actual Hours SP = Standard Price AP = Actual Price SH = Standard Hours

Actual Hours Actual Hours Standard Hours × × × Actual Price Standard Price Standard Price


Labor Price and Usage Variances

Hanson Inc. has the following direct labor standard to manufacture one Zippy:

1.5 standard hours per Zippy at $6.00 perdirect labor hour

Last week 1,550 direct labor hours were worked at a total labor cost of $9,610 to

make 1,000 Zippies.

Labor Variances Zippy

Labor Price variance$310 unfavorable

Labor Usage variance$300 unfavorable

1,550 hours 1,550 hours × × $6.20 per hour $6.00 per hour

= $9,610 = $9,300

Actual Hours Used Actual Hours Used Standard Hours × × × Actual Price per Hr Standard Price Per Hr Standard Price Per Hr

Hanson Labor Variances Summary

Actual CostColumn

Standard Cost

Column

Variance DividingColumn

Total Variance$610 Unfavorable$610 Unfavorable

1,500 hours

x

$6.00 per lb.

= $9,000

Responsibility for Labor Variances

Production Manager

Production managers areusually held accountable

for labor variancesbecause they can

influence the:

Mix of skill levelsMix of skill levelsassigned to work tasks. assigned to work tasks.

Mix of skill levelsMix of skill levelsassigned to work tasks. assigned to work tasks.

Level of employee Level of employee motivation.motivation.

Level of employee Level of employee motivation.motivation.

Quality of production Quality of production supervision.supervision.

Quality of production Quality of production supervision.supervision.

Quality of training Quality of training provided to employees.provided to employees.

Quality of training Quality of training provided to employees.provided to employees.

Responsibility for Labor Variances

I am not responsible forI am not responsible for the unfavorable labor the unfavorable labor

efficiency variance!efficiency variance!

You purchased cheapYou purchased cheapmaterial, so it took morematerial, so it took more

time to process. time to process.

I think it took more time to I think it took more time to process the materials process the materials

because the Maintenance because the Maintenance Department has poorly Department has poorly

maintained your equipment.maintained your equipment.

Production ManagerPurchasing Manager

Fixed Overhead VariancesVariable costs can have both price and usage variances. Fixed overhead costs

can have a price variance. The difference between the actual fixed

overhead costs paid and the budgeted fixed overhead costs is called the spending variance. At Melrose, the spending variance was:

($201,600 budgeted – $210,000 actual) = $8,400 Unfavorable($201,600 budgeted – $210,000 actual) = $8,400 Unfavorable($201,600 budgeted – $210,000 actual) = $8,400 Unfavorable($201,600 budgeted – $210,000 actual) = $8,400 Unfavorable

Fixed Overhead VariancesOverhead VolumeVolume Variance Rate

Budgeted Fixed Overhead Costs 201,600$ Planned Volume of Trophies 18,000 Predetermined Fixed Overhead Rate 11.20$

AllocationActual Volume of Trophies 19,000 Predetermined Fixed Overhead Rate 11.20$ Fixed Overhead Applied 212,800$

($201,600 ($201,600 budgetedbudgeted – $212,800 applied) = $11,200 Favorable – $212,800 applied) = $11,200 Favorable($201,600 ($201,600 budgetedbudgeted – $212,800 applied) = $11,200 Favorable – $212,800 applied) = $11,200 Favorable

Allocated to production

Fixed Overhead Variances

ActualActualFixedFixedCostCost

ActualActualFixedFixedCostCost

BudgetedBudgetedFixedFixedCostCost

BudgetedBudgetedFixedFixedCostCost

$210,000$210,000 $201,600$201,600

Spending Variance$8,400 UnfavorableUnfavorable

AppliedAppliedFixedFixedCostCost

AppliedAppliedFixedFixedCostCost

$212,800$212,800

Volume Variance$11,200 FavorableFavorable

End of Chapter Eight

Documents

Fundamental Managerial Accounting Concepts Thomas P. Edmonds Bor-Yi Tsay Philip R. Olds Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights