Management Accounting:
A Road of Discovery
Management Accounting:
A Road of Discovery
James T. Mackey
Michael F. Thomas
Presentations by:
Roderick S. Barclay
Texas A&M University - Commerce
James T. Mackey
California State University - Sacramento
© 2000 South-Western College Publishing
Chapter 6
Are we following the plan?
The need for variance
analysis
Key Learning Objectives
• Explain management by
exception and how it is a
feedback system.
• Calculate and interpret the sales
price and volume variances.
• Define the components of a
standard cost card, and list its
benefits and limitations.
• Calculate and interpret spending
and usage variances.
• Distinguish between boardroom
and process control, and explain
the usefulness of variance
analysis for these strategies.
• Compare ideal and practical
standards, and explain why
practical standards represent the
“one best way”.
PART I
THE COMPANY AS A WELL
DESIGNED MACHINE FOR
MANAGEMENT BY THE
NUMBERS
The Company

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Each Responsibility Center is a separate part
of the whole company.
‘Management by Exception’ — MBE or
variances from the plan.

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Means we only interfere if the plan is not being
met.
Managers can ‘drill down’ into variance reports
that show what resources were used during the
period.
Variances change the ‘black box’ into a ‘glass box’.
The Role of Budgets for
Management by Exception

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Accounting reports are hard data.
Accounting reports are designed to examine
responsibility centers or functional
departments.
Accounting reports provide information on the
use of resources within each department.
The variances for each resource are equal to
the change in budgeted profit!
Note: See Exhibit 6-2, p. 191 for an example
of a Profit Variance Report.
PART II
RELIABLE BUDGET MEASURES
Efficient MBE Relies on Accurate
Budgeting


The plan is only as good as the data that goes into it
— Garbage in = Garbage out!
How we make sure that the data used to plan is
correct.

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Use engineered or ‘the one best way’ standards with
Scientific Management.
The focus is on designing and maintaining ‘one best
way’ standards.
Not all budgets may be scientifically designed, but
they are contracts between responsibility center
managers and the company.
In practice the input data and the standards behind
them vary in degree of accuracy but responsibility
center managers have committed to meeting these
performance levels during the planning period.
Work and Price Standards


Engineered standards describe the best way
to perform an activity and the materials
needed to complete the product.
Good management means making sure
activities follow these rules!
Example
Concrete Bird Baths
Standard Cost Card
Direct materials — 50 lbs @ $3
Direct labor — 2 hours @ $10
Manufacturing overhead:
Variable — 2 DL hours @ $5 POR
Fixed — 2 DL hours @ $12.50 POR
= $150
=
20
Standard unit cost
= $200
=
=
5
25
More Work and Price Standards


Budgeting and Scientific Management
systems insure the original data is reliable.
Variances obtained from accounting reports
allow MBE practices.




Variance are the differences between actual and
planned results.
Variances measure the impact on target profit.
Variance identify which resources were not used
as planned — Which activities to investigate first!
Variance reports allow management to drill down
into the organization to examine t6he performance
of each responsibility center and its use of
resources.
PART III
HOW DO VARIANCE REPORTS
EXPLAIN SARAH’S COLLEGE
DILEMMA?
Sarah’s Earnings (revenue) Variances
Wages
earned:
Hours
Worked:
(Actual – Budgeted rate) x Actual Vol.
($8 / hr = $10 / hr) x 440 hours
(Actual – Budgeted hours) x Budget rate
(440 hours – 400 hours) x $ 10 / hr
Total
Earnings
Variance:
=
= ($880)U
= $400 F
($480)U
NOTE: F = favorable, U = unfavorable, or
earned more (F) or less (U) than
planned.
Sarah’s Cost Variances
Tuition
rate:
Hours
Worked:
(Budgeted - Actual rate) x Actual Vol.
($50 / credit - $60 / credit) x 15 credits
(Budgeted – Actual credits) x Budget rate
(16 credits – 15 credits ) x $ 50 / credit
Total
Tuition
Variance:
=
= ($150)U
= $ 50 F
($100)U
NOTE: Cost more (U) or less (F) than
planned.
Analysis of Sarah’s Dilemma

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She worked at a lower wage rate than planned — $10 - $8.
She worked more hours than planned — 400 – 440.
Cost changes are due to tuition rate changes — $50 – 460.
She isn’t taking as many credits as planned — 16 – 15.
Favorable variances (F) helped her budget.
Unfavorable variances (U) worsened her budget.
Relative impact:

Total tuition variance — $100U

Wages earned — $880U

Hours worked — $400F

Tuition price — $150U

Credits taken — $50F
The budget report allows you to ‘drill down’ into the process to
examine the reasons for her missing the budget.
What Does Sara’s Dilemma Tell Us?

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If Sara had analyzed her situation sooner she could
possibly have lessened her difficulties.
Sara tried to solve her own difficulties, she did not seek
help. (This is a typical business situation.)
Sara adapted to her situation — that is good, but with
help it might have been better. (A good business
lesson.)
If her actions were more visible, that would probably
have affected her behavior positively. (Another good
business lesson.)
Variance analysis tends to move Sara’s actions from a
‘black box’ to a ‘glass box’ by providing more
information about her activities and providing a better
control environment. (A lesson for business
management.)
Use our Knowledge to Analyze Multree’s
Home Profit Variance for February

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See Exhibit 6-2, p. 189.
Favorable or unfavorable means the variance
increased our actual profits or decreases our actual
profit respectively.
Standards allow companies to use flexible proforma
budgets within the relevant range.
For MBE, what function or functions would you
investigate?
Remember, these are the costs within our relevant
range. Thus these are unit based (linear) costs that
we can use at any volume.
PART IV
Calculating Variances for
Bird Baths
Variable Cost Variances


In the past month 800 units were produced and the
cost of materials was $123,500 (38,000 lbs @ $3.25)
but the budgeted costs for this level are $120,000.
The budgeted costs are calculated by multiplying the
standard for one unit by the volume of work
completed. That is, the standard for materials is $3 x
50 lbs multiplied by 800 completed units.
Variable Cost Variances
(Continued)
Variable
Costs
Actual Costs
‘Inputs’
Budgeted
Cost Variances
Costs ‘Outputs’
Direct
Materials
$3.25X38,000lb
s=$123,500
800($3x50lbs)
=$120,000
$3,500
Unfavorable
The ‘Unfavorable direct materials variance reduces the target
profit by $3,500.
We can drill down and break this variance into the two
components: Price and Quantity.
Price Variances

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Materials Price variances — the differences between the
actual and standard purchase price multiplied by the
materials used.
Where:
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PS = Standard price per unit of inputs.
PA = Actual price per unit of inputs.
QS = The budgeted resources for one unit.
QA = The actual resources consumed in total
X = Volume of good produced.
Variances due to price of materials = (PA-PS)QA.
(Actual-Standard prices)Materials used =
($3.25-$3.00)38,000 = $9,500 Unfavorable.
Because we paid more than planned, our target profit is
reduced by $9,500.
Usage or Efficiency Variances

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Variance due to materials used =
(actual inputs x standard prices) –
(standard input x standard prices) x good outputs.
Materials Usage and Efficiency variances =
PSQA – PSQSx.

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Therefore: Material Usage variance = $3.00 x 38,000
lbs -$3.00 x 50 lbs x 800 units = $6,000 F
That is: 38,000 lbs used versus (800 units x 50 lbs)
40,000 lbs that should have been used!
The usage variance cost is (40,00 vs. 38,000) or 2000
lbs at the standard cost of $3 / lb or $6,000 F
Thus our net impact on profit due to materials
variances is the price variance plus the usage
variance or 49,500U + $6,000F = $3,500U.
Usage or Efficiency Variances Summary.

We have drilled down into the company to
find the causes for the variances. Purchasing
and manufacturing are separate
Responsibility Centers. One has increased
target profits, the other hast not. Now it may
not be their fault, but the variances at least
tell us where to ask questions for
Management by Exception.
The General Formula
The same Formula can be applied to all variable costs
Variable Variances PAQA vs. PSQA
PQA vs. PSQSx
Direct materials
Purchase price variance Usage variance
Direct labor
Rate variance
Variable overhead Spending variance
Efficiency variance
Efficiency variance
Fixed Cost Variances

Drilling down into fixed costs.

Fixed costs do not change with variation in
volume. However, they can change because of
nonvolume related activities, like the weather, or a
tax ruling, etc. Therefore, we are interested in the
difference between actual and budgeted fixed
overhead for manufacturing costs.
Where Monthly Costs Are:
Actual fixed overhead Fixed overhead
recorded in the
spending variance
general ledger
Budgeted monthly
fixed overhead
$20,000
1/12 x $300,000 =
$25,000
$5,000 F
More Monthly Costs
We can calculate the fixed costs for Administration and Selling
Actual administration
Spending variance Budgeted
$10,000
Actual sales
None
$10,000
Spending variance Budgeted
$10,000
None
$10,000
Additional Fixed Manufacturing Variance
Caused by GAAP


Full costing means we have to ‘capitalize’
manufacturing costs into inventory accounts —
product costs. When the work done is not the same as
budgeted for the month, a “volume variance” occurs.
Illustration:


The predetermined overhead rate is $300,00/12,000
units at 23 hours each = $12.50 per direct labor hour.
This is the absorption or full costing accounting
convention.
If production is scheduled to be the same every
month, then $25,000 is budgeted monthly
($300,000/12).
(Continued)
Additional Fixed Manufacturing Variance
Caused by GAAP
(illustration continued)
Budgeted fixed
overhead
Fixed overhead
volume variance
Fixed overhead
applied using POR
for GAAP
1/12 x $300,000 =
$25,000
$5,000 less than
planned or
favorable
POR(QS)x =
$12.50 x 2hrs x
800 units =
$20,000
Sales Variances: Sales Price Variances

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Sales price variance = (PA – PS) QA
Where: The budgeted sales price is PS, the
actual sales price is PA and the actual sales
volume is QA.
Sales price variance = (PA – PS) QA
= ($280 - $275) 800 = $4,000F
Sales Variances: Sales Volume Variances

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Changes in the contribution margin directly changes
profits.
Chanes in variable costs are already included in the
previous variances.
Thus, sales price changes are equal to contribution
margin changes. For the sales volume variance, we
use the standard contribution margin SCM.
Sales volume variance = (Actual Volume – Budgeted
Volume) SCM.
= (800 – 1,000) $95 = $19,000U
PART V
Calculating Work Standards:
The One Best Way
Calculating Work Standards

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How do we set standards?
What are standard costs?
Remember the Scientific Method. Standards
are set from designing the most efficient
manner to perform this activity.
Setting the Labor Rate Standard
Labor Standard Cost Card
Average cost per direct labor hour =
Fringe benefits per hour =
Standard costs per direct labor hour =
$8.70
1.30
$10.00
Calculating Work Standards

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(continued)
Next we calculate the direct labort hours
required to make a bird bath. Using the
engineering calculations we can create the
‘Practical Standard’. The practical standard is
the performance that can be expected given
the current design of the operation.
The application of costs versus benefits
criteria to the calculation of standards is that
the costs of perfect production are not
justified by the benefits realized.
Labor Standard Calculation
Direct labor per unit ideal conditions =
Reject rate (10% x 1.8 hours =
Training =
1.8 hours
.18
.20
Labor Standard =
2.00 hours
Direct Materials Standards Calculation
Standard Materials Cost per lb.
Invoice cost =
Shipping costs =
Waste: approximate 5% x $2.90 =
Less: Discounts taken at 2% x $2.80 =
Standard cost per lb.
$2.80 per lb.
.10 per lb.
.146 per lb.
-.056 per lb.
$3.00 per lb.
Standard Materials Per Bird Bath
Direct materials per unit =
Spoilage at 5% =
Rejects at 10% =
Standard materials per unit =
43.5 lbs.
2.2 lbs.
4.3 lbs.
50 lbs.
Concrete Bird Baths
The Standard Cost Card
Direct Materials (50 lbs. X $3.00)
Direct Labor (2 hours x $10)
Manufacturing overhead:
Variable (2 DL hrs. x $5 POR)
Fixed (2 DL hrs x $12.50 POR)
= $150
=
20
Standard Unit Cost
= $205
=
=
10
25
Theoretical Standards Versus
Practical Standards

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Theoretical standards assume no reject rates
or failures.
The job is done perfectly.
The costs of perfection exceed the benefits.
Practical standards are cost efficient.
I.e., for direct labor it is 1.8 direct labor hrs
and for materials it is 43.5 lbs.
Benefits of Practical Standards

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Waste has a cost — waste prevention has a cost. We
must determine which has the least cost.
I.e., it does not make sense to spend $10 to prevent
$5 waste.
Practical standards are attainable, (perfection usually
is not) thus budgeting and planning is easier.
Consequently, budgets and plans are more accurate.
One result is better employee relations because our
expectations are attainable.
Another result is better employee performance
because they know they can meet management’s
expectations.
Multree Homes
Standard Homes Product Line
Standard Cost Card
Resources
Standard prices
Standard quantities
Direct
materials
Standard costs
$15,500 / house
Direct labor
$10.00 /hour
1,000 dl hrs /house
10,000 /house
Variable
overhead
$2.06 / dl hr.
1,000 dl hrs /house
2,060 /house
Fixed overhead $2.68 / dl hr.
1,000 dl hrs /house
2,680 /house
Standard absorptive manufacturing cost
$30,240 /house
Budgeted annual standard homes
Manufacturing costs =
$268,000 per year + $25,560 /house
Multree Homes
Custom Homes Product Line
Standard Cost Card
Resources
Standard prices
Standard quantities
Direct
materials
Standard costs
$26,250 / house
Direct labor
$10.00 /hour
2,500 dl hrs /house
25,000 /house
Variable
overhead
$2.06 / dl hr.
2,500 dl hrs /house
5,150 /house
Fixed overhead $2.68 / dl hr.
2,500 dl hrs /house
6,700 /house
Standard absorptive manufacturing cost
$63,100 /house
Budgeted annual standard homes
Manufacturing costs =
$67,000 per year + $56,400 /house
Notes on Cost Equation Calculations
Budgeted fixed overhead
$2.68/dl hr. x 1,000 dl hrs / house
allocation to standard homes = x 100 homes production quota
= $268,000
Budgeted fixed overhead
allocated to custom homes =
$2.68/dl hr. x 2,500 dl hrs / house
x 10 homes production quota
= $67,000
Standard variable cost for
standard homes line =
($15,500 + $10,000 + $2,060) / house
= $26,560
Standard variable cost for
custom homes line =
($26,250 + $25,000 + $5,150) / house
= $56,400
Profit Variance Analysis


Now, through variance analysis we can
reconcile the proforma profit to the
actual profit.
See Exhibit 6-9, p. 204 of your text for
a complete analysis of the process and
example of the calculations.
Benefits of Variance analysis — Summary

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Variances are useful for control purposes.
Variances communicate information to
management.
Variances affect the actions of organization
management.
Variances point out possible organizational
difficulties — management cannot fix what
they do not know about.
A greater amount of relevant information is
always beneficial for management and the
organization as a whole.