Budgets and Variances
continued:
Production variances
Agenda
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Return Reichard: recap main points
Midterm exam discussion
Briefly review production variances
Vanguard problem
Group work: Example Company
Reichard
• IC of 100 plastic rings = $32, CM = $293,
or $73 per 100 steel rings on an equivalent
basis of 4 steel rings =1 plastic ring.
• This assumes a price of $325/100.
• Current margins are about 20% on sales (1264/325) or 25% of Full Cost.
• If price drops to $82/100 for plastic, profit
per 100 rings = $15/100 * 9000 rings =
$1350 p.a. on current (equiv) sales volume
Reichard
• In fact, the entire market for plastic rings
will produce $13,500 p.a. in profits: less
than what Reichard earned on 10% of the
steel ring market!!!
• Is this any market for Reichard to be in?
• Should we bother to compete in plastic?
• Where do we go from here?
• How many proprietary parts do we have?
Midterm Exam
• The exam has five questions.
• Question 1: Cost estimation - regression (a make or buy
decision)
• Question 2: Production cost variances (compute 11
variances)
• Question 3: Manufacturing Costs and Accounts
• Question 4: Cost-volume-profit - minimum SP
• Question 5: Identifying relevant costs and revenues
Midterm self-evaluation of
participation:
• Get a copy of the form from the homepage: Go to
“Schedule of Work,” scroll to “Midterm Exam”, click
on “self-evaluation”
• The form contains some grading criteria; also use the
criteria attached to the syllabus.
• I have my grades already recorded. I record grades
after each class.
• I’ll write my midterm grade on your form and hand it
back to you with your exam.
Review of Tuesday’s discussion
• Variances are departures from budget
expectations - they are performance evaluation
measures.
• Each one measures a favorable or unfavorable
change in (budgeted) net income due to some
departure from planned sales and production.
• They do not, themselves, provide answers they trigger questions.
Review: What information do
variances convey?
• What do activity variances convey?
• What do price variances convey?
– Material and labor (price)
– Variable overhead (spending)
– Fixed overhead (budget)
• What do efficiency variances convey?
• What do production volume variances convey?
Variance computations:
• Price variances: Find the difference between the
budgeted and the actual prices and multiply the
difference by the actual number of units of the input
consumed/purchased.
• Quantity/efficiency variances: Find the difference
between the actual number of units of the input
consumed and the number of units the standards would
allow for good production and then multiply the
difference by the standard price of the input.
Variance computations
• Spending variance: Find the difference between
the actual amount spent on variable overhead and
the amount that would have been spent if the
predetermined overhead rate had accurately
predicted the price of variable overhead per unit of
the cost driver. (Actual - Std. Input)
• Budget variance: The difference between actual
fixed overhead spending and budgeted fixed
overhead. (Actual - Master Budget)
Variance computations
• The production volume variance measures the
difference between budgeted fixed overhead and the
amount of fixed overhead that has been included in
production costs. (Master Budget - Applied Overhead)
• An unfavorable PVV indicates less production than
planned: Idle capacity.
• A favorable PVV indicates that production (sales) levels
are more than adequate to cover the amount of fixed
overhead expected to be covered.
Example: The Vanguard
Company
The Vanguard Company manufactures one product. Its
standard cost system incorporates flexible budgets and
assigns indirect costs on the basis of standard DL hrs.
At denominator activity, the standard cost per unit is:
Direct materials, 3 lbs. @ $5.00
$15.00
Direct labor, .4 hr. @ $20.00
8.00
Variable indirect costs, .4 hr. @ $6.00
Fixed indirect costs, .4 hr. @ $4.00
Total
2.40
1.60
$27.00
Example: The Vanguard
Company
DM
Actual Standard Total
Price
Eff.
Price
Costs
Var.
Var.
Var.
$134,400 $135,000 $600
$5,600 F $5,000 U
DL
77,900
72,000
5,900
VOH
VOH
21,500
21,600
FOH
15,800
14,400
PVV
---
1,900 U 4,000 U
---
100
1,300
---
1,400
200
$249,600 $243,000 $6,600
$5,200
1,200 U
--
$1,600 U
$10,200 U $1,600 U
Example: The Vanguard
Company
Actual
Costs
DM
Applied
Std.
Costs
Total
Var.
Price
Var.
$134,400 $135,000 $ 600 F $5,600 F
DL
77,900
72,000
5,900 U 1,900 U
VOH
21,500
21,600
100 F
1,300 F
FOH
15,800
14,400 1,400 U
200 F
Efficiency
Var.
PVV
$5,000 U
--
4,000 U
--
1,200 U
--
--
$1,600 U
Total $249,600 $243,000 $6,600 U $5,200 F $10,200 U $1,600 U
Example: The Vanguard
Company
Direct materials were quoted at $5.50 per pound throughout September and October to all suppliers. There was no
purchase-price variance for materials in October; the
price variance shown relates solely to the materials used
during October.
Wage standards were set in accordance with an annual
union contract, but a shortage of workers in the local
areas has resulted in rates higher than standard.
There were no beginning or ending inventories of work
in process.
Example: The Vanguard
Company
1. How many units were produced?
Use the standard cost column.
All the units manufactured cost $243,000 at standard
One unit at standard costs $27.00
Units produced = $243,000 / $27.00 = 9,000 units
Example: The Vanguard
Company
2. What were the actual number of direct labor hours
used?
Efficiency variance = (actual hrs./unit - std. hrs./unit)
x actual output x std. price
= [actual DL hrs. - (.4 x 9,000)]
x $20
$4,000 = actual DL hrs. x $20 - $72,000
$76,000 = actual DL hrs. x $20
3,800 = actual DL hrs.
Example: The Vanguard
Company
3. What was the actual wage rate?
Labor price variance = (actual rate - std. rate) x
actual labor hours
$1,900 = (actual wage rate - $20.00) x 3,800 hrs.
$1,900 = actual wage rate x 3,800 hrs - $76,000
$77,900 = actual wage rate x 3,800 hrs
$20.50 = actual wage rate
Example: The Vanguard
Company
4. What was the budget for fixed indirect costs.
FOH budget variance = Budgeted FOH - Actual FOH
$200 = Budgeted FOH - $15,800
Actual FOH < Budgeted FOH
$16,000 = Budgeted FOH
Example: The Vanguard
Company
5. Denominator activity expressed in direct labor hours.
Look at FOH applied:
Budgeted FOH
x std.hrs. x actual output  $14,400
Denominato r Volume
Budgeted FOH
x .4 hrs. x 9,000  $14,400
Denominato r Volume
$16,000
x .4 hrs. x 9,000  $14,400
Denominato r Volume
Denominator Volume = 4,000 DL hrs.
Example: The Vanguard
Company
6. How many pounds of direct materials were used?
DM quantity variance = (actual quantity used std. quantity for output) x
standard price
$5,000 = (actual quantity used - (3 lbs. x 9,000)) x $5.00
$5,000 = actual quantity used x $5.00 - $135,000
$140,000 = actual quantity used x $5.00
28,000 lbs. = actual quantity used
Example: The Vanguard
Company
7. How many pounds of direct material were purchased?
We cannot compute that number from the
information given.
Tuesday & Thursday
• Midterm exam - 8:00 a.m., 152 Comm. West
• Thursday: Waltham Motors
– Hand in a memo and computations
Group exercise
• Use Example Company: Look at the
numbers and determine what they all mean.
• Compute
– Direct material price, quantity and activity
variances
– Direct labor rate, quantity and activity
variances
– Overhead variances: spending/budget,
efficiency (if applicable), and PVV