Managerial Accounting chapter 21

Cost variance computation pt 2

1. Actual quantity (AQ ) Standard quantity (SQ) x Actual price (AP) x Standard price (SP) Actual Cost (AC) Standard Cost (SC) 2. Actual quantity is actual amount of material or labor used in manufacturing the actual quantity of output during the period, and Standard Quantity is the input expected for the quantity of output. 3. Actual Price is amount paid for acquiring the input (material or labor), and Standard Price is the expected price. 4. Two main factors cause a cost variance a. Price variance caused by difference between actual price paid and standard price. b. Quantity (or usage or efficiency) variance caused by difference between the actual quantities of materials or hours used and the standard quantity.

Budgetary Control and Reporting (Budgetary process)

1. Budgetary control - managers use budgets to control operations and see that planned objectives are met. 2. Budget Reports

Flexible Budget Performance Report

1. Compares actual performance and budgeted performance based on actual sales volume (or other level of activity). 2. Helps direct management's attention to those costs or revenues that differ substantially from budgeted amounts; areas where corrective actions may help management control operations. 3. Used for variance analysis.

Standard costs are preset costs for delivering a product or service expected under normal conditions.

1. Used by management to assess the reasonableness of actual costs incurred for producing the product or service. 2. When actual costs vary from standard costs, management follows up to identify potential problems and take corrective action. 3. Management by exception: managers focus attention on most significant differences and give less attention where performance is reasonably close to standard. 4. Often used in preparing budgets because they are the anticipated costs incurred under normal conditions. 5. Can also help control nonmanufacturing costs.

Standard costing

Actual costs are amounts paid in past transactions; a measure of comparison is usually needed to decide whether actual cost amounts are reasonable or excessive, and standard costs offer one basis for comparison.

Fixed Budget Performance Report

a. A fixed budget performance report compares actual results with results expected under the fixed budget (that predicted a certain sales volume or other activity level). (Exhibit 21.2) b. Differences between budgeted and actual results are designated as variances.

Due to inefficiencies and waste, materials may be lost as part of process.

a. An ideal standard is the quantity of material required if process was 100% efficient without any loss or waste. b. A practical standard is the quantity of material required under normal application of process. The standard direct labor rate should include allowances for employee breaks, cleanup, and machine downtime. c. Most companies use practical standards

Favorable variance

actual revenue is greater than budgeted revenue, or actual cost is lower than budgeted cost.

unfavorable variance

Actual revenue is lower than budgeted revenue, or actual cost is greater than budgeted cost.

A standard cost card shows

the standard costs of direct materials, direct labor, and overhead for one unit of product or service.

Is a flexible budget more useful than a fixed budget?

A flexible budget is more useful when actual results are different from predicted.

Budget Reports for Evaluation

Budgetary process

Fixed budget reports show variances from budget, but manager doesn't know if a change in sales volume (or other activity level) is cause for variances, or if other factors have influenced the amounts.

Budgetary process

Major limitation of fixed budget performance report is inability of fixed budget reports to adjust for changes in activity levels.

Budgetary process

Managers use budget reports is to monitor and control operations.

Budgetary process

Flexible Budget reports

Superior alternative to fixed budget reports.

Alternative price variance and quantity variance formulas can also be used. (Labor)

c. Rate variance = (Actual rate - Standard rate) x Actual hours. RV = (AR - SR) x AH. d. Efficiency variance = (Actual hours - Standard hours) x Standard rate. EV = (AH - SH) x SR.

Purpose of Flexible budgets

1. Flexible budget (also called variable budget) is based on predicted amounts of revenues and expenses corresponding to actual level of output. 2. Useful both before and after the period's activities are complete 3. Flexible budgets prepared before the period, are based on several levels of activities. Include both best case and worst case scenarios 4. Flexible budgets prepared after the period help managers evaluate past performance. 5. Especially useful because it reflects the different levels of activities in different amounts of revenues and costs. a. Comparisons of actual results with budgeted performance are more likely to reveal the causes of any differences. b. Helps managers to focus attention on problem areas and to implement corrective actions.

Cost Variance Analysis

1. Variances are commonly identified in performance reports. 2. Management examines circumstances to determine factors causing the variance; analysis, evaluation, and explanation involved. 3. Results of efforts should allow assignment of responsibility for the variance; actions can then be taken to correct problems. 4. Four steps involved in proper management of variance analysis. a. Preparation of standard cost performance report. b. Computation and analysis of variances. c. Identification of questions and their explanations. d. Corrective and strategic action.

Cost variance computation

Cost variance (CV) equals difference between actual cost (AC) and standard cost (SC).

Fixed Budgeting (Budgetary process)

a fixed budget (also called a static budget) is based on a single product amount of sales or other activity measure.

Flexible Budgeting (Budgetary process)

a flexible budget (also called a variable budget) is based on several different amounts of sales or activity levels.

Material cost variances may be due to price and/or quantity factors.

a. A materials price variance results when company pays different amount per unit than standard price; purchasing department usually responsible. b. A material quantity or usage variance results when company uses a quantity that differs from the standard quantity allowed to produce the actual amount of output; production department usually responsible. Can also be fault of purchasing department if the purchase of inferior materials caused excess use of materials.

Variance analysis

a. Actual and budgeted sales volumes are the same; as such, any variance in total dollar sales must have resulted from a selling price that was different than expected. b. Difference between actual price per unit of input and budgeted price per unit of input can be described as a price variance. c. Difference between actual quantity of input used and budgeted quantity can be described as a quantity variance.

Regardless, actual costs frequently differ from standard costs; differences often due to more than one factor.

a. Actual quantity used (of direct labor hours or direct materials) may differ from standard. b. Actual price paid per unit (of direct labor or direct materials) may differ from standard.

When numbers making up a flexible budget are created:

a. Each variable cost is expressed as either a constant amount per unit of sales or as a percent of sales dollar. b. Budgeted amount of fixed cost is expressed as the total amount expected to occur at any sales volume within the relevant range.

Preparation of Flexible Budgets

a. Identify the activity level, units produced or sold. b. Identify costs and classify them as fixed or variable c. Computed budgeted sales and then subtract the sum of budgeted variable costs.

Labor cost variances may be due to rate (price) and/or efficiency (quantity) factors.

a. Labor rate (price) variance results when wage rate paid to employees differs from standard rate; personnel administrator or production manager need to explain why the actual rate is higher or lower than standard b. Labor efficiency (quantity) variances results when labor hours used differ from the standard quantity of hours allowed to produce the actual amount of output; production manager needs to explain why the actual hours were different from standard. c. Labor rate and efficiency variances may be due to use of workers with different skill levels.

Common periods for budget reports are for a month, a quarter and for a year. (Budgetary process)

a. Master budget is based on a predicted level of activity, such as sales volume, for the budget period. b. Two alternative approaches: fixed budgeting or flexible budgeting.

Alternative price variance and quantity variance formulas can also be used. (materials)

a. Price variance = (Actual price - Standard price) x Actual quantity. PV = (AP - SP) x AQ. b. Quantity variance = (Actual quantity - Standard quantity) x Standard price. QV = (AQ - SQ) x SP.

Layout follows a contribution margin format

a. Sales are followed by variable costs (per unit), and then by fixed costs-difference between sales and variable costs equals contribution margin. b. First column shows flexible budget amounts of variable costs per unit, and second column shows fixed costs for any volume of sales in relevant range. c. Third, fourth, and fifth columns show flexible budget amounts computed for specified sales volumes (three different sales volumes used in this example). d. Total Budgeted Costs = Total Fixed Cost + (Total Variable Cost Per Unit x Units of Activity).

Managerial accountants, engineers, personnel administrators, purchasing managers, and production managers work together to set standard costs.

a. To set direct labor costs - conduct time and motion studies for each labor operation in the process of providing product or service; sets standard labor time required for each operation under normal conditions. b. To set direct material costs - study quantity, grade, and cost of each material used.

Must classify costs as variable and fixed within a relevant range. (flexible)

a. Variable cost per unit of activity remains constant; total amount of variable cost changes in direct proportion to a change in level of activity. b. Total amount of fixed cost remains unchanged regardless of changes in level of activity within relevant (normal) operating range.

Cost variances

difference between actual and standard costs; can be favorable (if actual cost is less than standard cost) or unfavorable (if actual cost is more than standard cost). Note that short-term favorable variances can lead to long-term unfavorable variances