CHAPTER
23
Performance Evaluation
Using Variances from
Standard Costs
Warren
Reeve
Duchac
human/iStock/360/Getty Images
Accounting
26e
Standards
(slide 1 of 2)
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•
Standards are performance goals.
Manufacturing companies normally use standard cost
for each of the three following product costs:
o
o
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Direct materials
Direct labor
Factory overhead
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Standards
(slide 2 of 2)
•
Accounting systems that use standards for product
costs are called standard cost systems.
o
Standard cost systems enable management to determine
the following:
 How much a product should cost (standard cost)
 How much it does cost (actual cost)
•
When actual costs are compared with standard costs,
the exceptions or variances are reported.
o
This reporting by the principle of exceptions allows
management to focus on correcting the cost variances.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Setting Standards
•
The standard-setting process normally requires the
joint efforts of accountants, engineers, and other
management personnel.
o
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The accountant converts the results of judgments and process
studies into dollars and cents.
Engineers with the aid of operation managers identify the
materials, labor, and machine requirements needed to
produce the product.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Types of Standards
•
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Ideal standards, or theoretical standards, are
standards that can be achieved only under perfect
operating conditions, such as no idle time, no machine
breakdowns, and no materials spoilage.
Currently attainable standards, sometimes called
normal standards, are standards that can be attained
with reasonable effort.
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Criticisms of Standard Costs
•
Some criticisms of using standard costs for
performance evaluation include the following:
o
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Standards limit operating improvements by discouraging
improvement beyond the standard.
Standards are too difficult to maintain in a dynamic
manufacturing environment, resulting in “stale standards.”
Standards can cause employees to lose sight of the larger
objectives of the organization by focusing only on efficiency
improvements.
Standards can cause employees to unduly focus on their
own operations to the possible harm of other operations
that rely on them.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Budgetary Performance Evaluation
(slide 1 of 2)
•
The budgetary performance evaluation compares the
actual performance against the budget.
o
The standards for direct materials, direct labor, and factory
overhead are separated into the following two components:
 Standard price
 Standard quantity
o
The standard cost per unit for direct materials, direct labor,
and factory overhead is computed as follows:
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Budgetary Performance Evaluation
(slide 2 of 2)
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The master budget is prepared based on planned
sales and production.
o
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The budgeted costs for materials purchases, direct labor,
and factory overhead are determined by multiplying their
standard costs per unit by the planned level of production.
Budgeted (standard) costs are then compared to actual
costs during the year for control purposes.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Budget Performance Report
•
The differences between actual and standard costs
are called costs variances.
o
o
•
A favorable cost variance occurs when the actual cost is
less than the standard cost (at actual volumes).
An unfavorable cost variance occurs when the actual cost
exceeds the standard cost.
The report that summarizes actual costs, standard
costs, and the differences for the units produced is
called a budget performance report.
o
The budget performance report is based on actual
production rather than planned production.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Manufacturing Cost Variances
(slide 1 of 4)
•
•
The total manufacturing cost variance is the
difference between total standard costs and total
actual cost for the units produced.
For control purposes, each product cost variance is
separated into two additional variances.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Manufacturing Cost Variances
(slide 2 of 4)
•
The total direct materials variance is separated into a
price and quantity variance.
o
This is because standard and actual direct materials costs
are computed as follows:
 Thus, the actual and standard direct materials costs may differ
because of a price difference (variance), a quantity difference
(variance), or both.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Manufacturing Cost Variances
(slide 3 of 4)
•
The total direct labor variance is separated into a
rate and a time variance.
o
This is because standard and actual direct labor costs are
computed as follows:
 Therefore, the actual and standard direct labor costs may differ
because of a rate difference (variance), a time difference
(variance), or both.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Manufacturing Cost Variances
(slide 4 of 4)
•
The total factory overhead variance is separated into
a controllable variance and a volume variance.
o
Because factory overhead has fixed and variable cost
elements, it uses different variances than direct materials
and direct labor, which are variable costs.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Direct Materials Price Variance
•
The direct materials price variance is computed as
follows:
o
If the actual price per unit exceeds the standard price per
unit, the variance is unfavorable.
 This positive amount (unfavorable variance) can be thought of as
increasing costs (a debit).
o
If the actual price per unit is less than the standard price
per unit, the variance is favorable.
 This negative amount (favorable variance) can be thought of as
decreasing costs (a credit).
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Direct Materials Quantity Variance
•
The direct materials quantity variance is computed as
follows:
o
If the actual quantity for the units produced exceeds the
standard quantity, the variance is unfavorable.
 This positive amount (unfavorable variance) can be thought of as
increasing costs (a debit).
o
If the actual quantity for the units produced is less than the
standard quantity, the variance is favorable.
 This negative amount (favorable variance) can be thought of as
decreasing costs (a credit).
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Direct Labor Rate Variance
•
The direct labor rate variance is computed as follows:
o
If the actual rate per hour exceeds the standard rate per
hour, the variance is unfavorable.
 This positive amount (unfavorable variance) can be thought of as
increasing costs (a debit).
o
If the actual rate per hour is less than the standard rate per
hour, the variance is favorable.
 This negative amount (favorable variance) can be thought of as
decreasing costs (a credit).
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Direct Labor Time Variance
•
The direct labor time variance is computed as follows:
o
If the actual direct labor hours for the units produced
exceeds the standard direct labor hours, the variance is
unfavorable.
 This positive amount (unfavorable variance) can be thought of as
increasing costs (a debit).
o
If the actual direct labor hours for the units produced is less
than the standard direct labor hours, the variance is
favorable.
 This negative amount (favorable variance) can be thought of as
decreasing costs (a credit).
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Factory Overhead Variances
•
Factory overhead costs are analyzed differently than
direct labor and materials costs.
o
•
This is because factory overhead costs have fixed and
variable cost elements.
Factory overhead costs are budgeted and controlled
by separating factory overhead into fixed and
variable components.
o
Doing so allows the preparation of flexible budgets and the
analysis of factory overhead controllable and volume
variances.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Factory Overhead Flexible Budget
(slide 1 of 2)
•
The budgeted factory overhead rate for Western
Rider is computed as follows:
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Factory Overhead Flexible Budget
(slide 2 of 2)
•
For analysis purposes, the budgeted factory
overhead rate is subdivided into a variable factory
overhead rate and a fixed factory overhead rate.
For Western Rider, the variable overhead rate and
the fixed overhead rate are computed as follows:
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Variable Factory Overhead
Controllable Variance
(slide 1 of 2)
•
•
The variable factory overhead controllable variance
is the difference between the actual variable
overhead costs and the budgeted variable overhead
for actual production.
The variable factory overhead controllable variance
is computed as follows:
o
o
If the actual variable overhead is less than the budgeted
variable overhead, the variance is favorable.
If the actual variable overhead exceeds the budgeted
variable overhead, the variance is unfavorable.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Variable Factory Overhead
Controllable Variance
(slide 2 of 2)
•
•
The budgeted variable factory overhead is the
standard variable overhead for the actual units
produced.
The budgeted variable factory overhead is computed
as follows:
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Fixed Factory Overhead Volume Variance
•
•
The fixed factory overhead volume variance is the
difference between the budgeted fixed overhead at
100% of normal capacity and the standard fixed
overhead for the actual units produced.
The fixed factory overhead volume variance is
computed as follows:
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Factory Overhead Cost Variance Report
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Factory Overhead Account
(slide 1 of 3)
•
At the end of the period, the factory overhead
account normally has a balance.
o
A debit balance in Factory Overhead represents
underapplied overhead.
 Underapplied overhead occurs when actual factory overhead costs
exceed the applied factory overhead.
o
A credit balance in Factory Overhead represents
overapplied overhead.
 Overapplied overhead occurs when actual factory overhead costs
are less than the applied factory overhead.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Factory Overhead Account
(slide 2 of 3)
•
•
The difference between the actual factory overhead
and the applied factory overhead is the total factory
overhead cost variance.
Thus, underapplied and overapplied factory
overhead account balances represent the following
total factory overhead cost variances:
o
o
Underapplied Factory Overhead = Unfavorable Total
Factory Overhead Cost Variance
Overapplied Factory Overhead = Favorable Total Factory
Overhead Cost Variance
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Factory Overhead Account
(slide 3 of 3)
•
The variable factory overhead controllable variance and the
volume variance can be computed by comparing the factory
overhead account with the budgeted total overhead for the
actual level produced.
o
The variable factory overhead controllable variance is the difference
between the actual overhead incurred and the budgeted overhead.
 If the actual factory overhead exceeds (is less than) the budgeted factory
overhead, the controllable variance is unfavorable (favorable).
o
The variable factory overhead volume variance is the difference
between the applied overhead and the budgeted overhead.
 If the applied factory overhead is less than (exceeds) the budgeted factory
overhead, the volume variance is unfavorable (favorable).
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Recording and Reporting Variances
(slide 1 of 4)
•
Standard costs may be used as a management tool to
control costs separately from the accounts in the
general ledger.
o
However, many companies include standard costs in their
accounts.
 One method for doing so records sustained costs and variances at
the same time the actual product costs are recorded.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Recording and Reporting Variances
(slide 2 of 4)
•
The journal entries to record the standard costs and
variances for direct labor are similar to those for
direct materials. These entries are summarized as
follows:
o
o
o
o
Work in Process is debited for the standard cost of direct
labor.
Wages Payable is credited for the actual direct labor cost
incurred.
Direct Labor Rate Variance is debited for an unfavorable
variance and credited for a favorable variance.
Direct Labor Time Variance is debited for an unfavorable
variance and credited for a favorable variance.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Recording and Reporting Variances
(slide 3 of 4)
•
The factory overhead account already incorporates standard
costs and variances into its journal entries.
o
o
o
o
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Factory Overhead is debited for actual factory overhead and credited
for applied (standard) factory overhead.
The ending balance of factory overhead (overapplied and
underapplied) is the total factory overhead cost variance.
By comparing the actual factory overhead with the budgeted factory
overhead, the controllable variance can be determined.
By comparing the budgeted factory overhead with the applied factory
overhead, the volume variance can be determined.
When goods are completed, Finished Goods is debited and Work in
Process is credited for the standard cost of the product transferred.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Recording and Reporting Variances
(slide 4 of 4)
• At the end of the period, the balances of each of the
•
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variance accounts indicate the net favorable or
unfavorable variance for the period. These variances
may be reported in an income statement prepared for
management’s use.
Variances are not reported to external users.
In preparing an income statement for external users,
the balances of the variance accounts are normally
transferred to Cost of Goods Sold.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Variance from Standards in Income Statement
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Nonfinancial Performance Measures
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A nonfinancial performance measure expresses
performance in a measure other than dollars.
o
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Such measures are often used to evaluate the time, quality,
or quantity of a business activity.
Nonfinancial measures are often linked to either the
inputs or outputs of an activity or process.
o
A process is a sequence of activities for performing a
particular task.
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.