Wk 6 – Managerial Analysis

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Standard Costs and Balanced Scorecard

CHAPTER PREVIEW

Standards are a fact of life. You met the admission standards for the school you are attending. The vehicle that you drive had to meet certain governmental emissions standards. The hamburgers and salads that you eat in a restaurant have to meet certain health and nutritional standards before they can be sold. As described in our Feature Story, Starbucks has standards for the costs of its materials, labor, and overhead. The reason for standards in these cases is very simple: They help to ensure that overall product quality is high while keeping costs under control.

In this chapter, we continue the study of controlling costs. You will learn how to evaluate performance using standard costs and a balanced scorecard.

80,000 Different Caffeinated Combinations

When Howard Schultz purchased a small Seattle coffee‐roasting business in 1987, he set out to create a new kind of company. He thought the company should sell coffee by the cup in its store, in addition to the bags of roasted beans it already sold. He also saw the store as a place where you could order a beverage, custom‐made to your unique tastes, in an environment that would give you the sense that you had escaped, if only momentarily, from the chaos we call life. Finally, Schultz believed that the company would prosper if employees shared in its success.

In a little more than 20 years, Howard Schultz's company, Starbucks, grew from that one store to over 17,000 locations in 54 countries. That is an incredible rate of growth, and it didn't happen by accident. While Starbucks does everything it can to maximize the customer's experience, behind the scenes it needs to control costs. Consider the almost infinite options of beverage combinations and variations at Starbucks. The company must determine the most efficient way to make each beverage, it must communicate these methods in the form of standards to its employees, and it must then evaluate whether those standards are being met.

Schultz's book, Onward: How Starbucks Fought for Its Life Without Losing Its Soul, describes a painful period in which Starbucks had to close 600 stores and lay off thousands of employees. However, when a prominent shareholder suggested that the company eliminate its employee healthcare plan, as so many other companies had done, Schultz refused. The healthcare plan represented one of the company's most tangible commitments to employee well‐being as well as to corporate social responsibility. Schultz feels strongly that providing health care to the company's employees is an essential part of the standard cost of a cup of Starbucks' coffee.

LEARNING OBJECTIVE 1

Describe standard costs.

Standards are common in business. Those imposed by government agencies are often called regulations. They include the Fair Labor Standards Act, the Equal Employment Opportunity Act, and a multitude of environmental standards. Standards established internally by a company may extend to personnel matters, such as employee absenteeism and ethical codes of conduct, quality control standards for products, and standard costs for goods and services. In managerial accounting, standard costs are predetermined unit costs, which companies use as measures of performance.

We focus on manufacturing operations in this chapter. But you should recognize that standard costs also apply to many types of service businesses as well. For example, a fast‐food restaurant such as McDonald's knows the price it should pay for pickles, beef, buns, and other ingredients. It also knows how much time it should take an employee to flip hamburgers. If the company pays too much for pickles or if employees take too much time to prepare Big Macs, McDonald's notices the deviations and takes corrective action. Not‐for‐profit entities, such as universities, charitable organizations, and governmental agencies, also may use standard costs as measures of performance.

Standard costs offer a number of advantages to an organization, as shown in Illustration 23-1 . The organization will realize these advantages only when standard costs are carefully established and prudently used. Using standards solely as a way to place blame can have a negative effect on managers and employees. To minimize this effect, many companies offer wage incentives to those who meet the standards.

ILLUSTRATION 23-1 Advantages of standard costs

DISTINGUISHING BETWEEN STANDARDS AND BUDGETS

Both standards and budgets are predetermined costs, and both contribute to management planning and control. There is a difference, however, in the way the terms are expressed. A standard is a unit amount. A budget is a total amount. Thus, it is customary to state that the standard cost of direct labor for a unit of product is, say, $10. If the company produces 5,000 units of the product, the $50,000 of direct labor is the budgeted labor cost. A standard is the budgeted cost per unit of product. A standard is therefore concerned with each individual cost component that makes up the entire budget.

There are important accounting differences between budgets and standards. Except in the application of manufacturing overhead to jobs and processes, budget data are not journalized in cost accounting systems. In contrast, as we illustrate in the appendix to this chapter, standard costs may be incorporated into cost accounting systems. Also, a company may report its inventories at standard cost in its financial statements, but it would not report inventories at budgeted costs.

SETTING STANDARD COSTS

The setting of standard costs to produce a unit of product is a difficult task. It requires input from all persons who have responsibility for costs and quantities. To determine the standard cost of direct materials, management consults purchasing agents, product managers, quality control engineers, and production supervisors. In setting the standard cost for direct labor, managers obtain pay rate data from the payroll department. Industrial engineers generally determine the labor time requirements. The managerial accountant provides important input for the standard‐setting process by accumulating historical cost data and by knowing how costs respond to changes in activity levels.

To be effective in controlling costs, standard costs need to be current at all times. Thus, standards are under continuous review. They should change whenever managers determine that the existing standard is not a good measure of performance. Circumstances that warrant revision of a standard include changed wage rates resulting from a new union contract, a change in product specifications, or the implementation of a new manufacturing method.

Ideal versus Normal Standards

Companies set standards at one of two levels: ideal or normal. Ideal standards represent optimum levels of performance under perfect operating conditions. Normal standards represent efficient levels of performance that are attainable under expected operating conditions.

Some managers believe ideal standards will stimulate workers to ever‐increasing improvement. However, most managers believe that ideal standards lower the morale of the entire workforce because they are difficult, if not impossible, to meet. Very few companies use ideal standards.

Most companies that use standards set them at a normal level. Properly set, normal standards should be rigorous but attainable. Normal standards allow for rest periods, machine breakdowns, and other “normal” contingencies in the production process. In the remainder of this chapter, we will assume that standard costs are set at a normal level.

ACCOUNTING ACROSS THE ORGANIZATION

U.S. Navy

How Do Standards Help a Business?

A number of organizations, including corporations, consultants, and governmental agencies, share information regarding performance standards in an effort to create a standard set of measures for thousands of business processes. The group, referred to as the Open Standards Benchmarking Collaborative, includes IBM, Procter and Gamble, the U.S. Navy, and the World Bank. Companies that are interested in participating can go to the group's website and enter their information.

Source: Becky Partida, “Benchmark Your Manufacturing Performance,” Control Engineering (February 4, 2013).

How will the creation of such standards help a business or organization? (Go to WileyPLUS for this answer and additional questions.)

ETHICS NOTE

When standards are set too high, employees sometimes feel pressure to consider unethical practices to meet these standards.

A Case Study

To establish the standard cost of producing a product, it is necessary to establish standards for each manufacturing cost element—direct materials, direct labor, and manufacturing overhead. The standard for each element is derived from the standard price to be paid and the standard quantity to be used.

To illustrate, we use an extended example. Xonic Beverage Company uses standard costs to measure performance at the production facility of its caffeinated energy drink, Xonic Tonic. Xonic produces one‐gallon containers of concentrated syrup that it sells to coffee and smoothie shops, and other retail outlets. The syrup is mixed with ice water or ice “slush” before serving. The potency of the beverage varies depending on the amount of concentrated syrup used.

DIRECT MATERIALS The direct materials price standard is the cost per unit of direct materials that should be incurred. This standard is based on the purchasing department's best estimate of the cost of raw materials. This cost is frequently based on current purchase prices. The price standard also includes an amount for related costs such as receiving, storing, and handling. The materials price standard per pound of material for Xonic Tonic is as follows.

Item	Price
Purchase price, net of discounts	$ 2.70
Freight	0.20
Receiving and handling	0.10
Standard direct materials price per pound	$3.00

ILLUSTRATION 23-2 Setting direct materials price standard

The direct materials quantity standard is the quantity of direct materials that should be used per unit of finished goods. This standard is expressed as a physical measure, such as pounds, barrels, or board feet. In setting the standard, management considers both the quality and quantity of materials required to manufacture the product. The standard includes allowances for unavoidable waste and normal spoilage. The standard quantity per unit for Xonic Tonic is shown in Illustration 23-3 .

Item	Quantity (Pounds)
Required materials	3.5
Allowance for waste	0.4
Allowance for spoilage	0.1
Standard direct materials quantity per unit	4.0

ILLUSTRATION 23-3 Setting direct materials quantity standard

The standard direct materials cost per unit is the standard direct materials price times the standard direct materials quantity. For Xonic, the standard direct materials cost per gallon of Xonic Tonic is $12.00 ($3×4 pounds)$12.00 ($3×4 pounds).

DIRECT LABOR The direct labor price standard is the rate per hour that should be incurred for direct labor. This standard is based on current wage rates, adjusted for anticipated changes such as cost of living adjustments (COLAs). The price standard also generally includes employer payroll taxes and fringe benefits, such as paid holidays and vacations. For Xonic, the direct labor price standard is as follows.

Item	Price
Hourly wage rate	$ 12.50
COLA	0.25
Payroll taxes	0.75
Fringe benefits	1.50
Standard direct labor rate per hour	$15.00

ILLUSTRATION 23-4 Setting direct labor price standard

The direct labor quantity standard is the time that should be required to make one unit of the product. This standard is especially critical in labor‐intensive companies. Allowances should be made in this standard for rest periods, cleanup, machine setup, and machine downtime. Illustration 23-5 shows the direct labor quantity standard for Xonic.

Item	Quantity (Hours)
Actual production time	1.5
Rest periods and cleanup	0.2
Setup and downtime	0.3
Standard direct labor hours per unit	2.0

ILLUSTRATION 23-5 Setting direct labor quantity standard

The standard direct labor cost per unit is the standard direct labor rate times the standard direct labor hours. For Xonic, the standard direct labor cost per gallon is $30 ($15×2 hours)$30 ($15×2 hours).

ALTERNATIVE TERMINOLOGY

The direct labor price standard is also called the direct labor rate standard.

ALTERNATIVE TERMINOLOGY

The direct labor quantity standard is also called the direct labor efficiency standard.

MANUFACTURING OVERHEAD For manufacturing overhead, companies use a standard predetermined overhead rate in setting the standard. This overhead rate is determined by dividing budgeted overhead costs by an expected standard activity index. For example, the index may be standard direct labor hours or standard machine hours.

As discussed in Chapter 17 , many companies employ activity‐based costing (ABC) to allocate overhead costs. Because ABC uses multiple activity indices to allocate overhead costs, it results in a better correlation between activities and costs incurred than do other methods. As a result, the use of ABC can significantly improve the usefulness of standard costing for management decision‐making.

Xonic uses standard direct labor hours as the activity index. The company expects to produce 13,200 gallons of Xonic Tonic during the year at normal capacity. Normal capacity is the average activity output that a company should experience over the long run. Since it takes two direct labor hours for each gallon, total standard direct labor hours are 26,400 (13,200 gallons×2 hours)26,400 (13,200 gallons×2 hours).

At normal capacity of 26,400 direct labor hours, overhead costs are expected to be $132,000. Of that amount, $79,200 are variable and $52,800 are fixed. Illustration 23-6 shows computation of the standard predetermined overhead rates for Xonic.

Budgeted Overhead Costs	Amount	÷	Standard Direct Labor Hours	=	Overhead Rate per Direct Labor Hour
Variable	$ 79,200		26,400		$3.00
Fixed	52,800		26,400		2.00
Total	$132,000		26,400		$5.00

ILLUSTRATION 23-6 Computing predetermined overhead rates

The standard manufacturing overhead cost per unit is the predetermined overhead rate times the activity index quantity standard. For Xonic, which uses direct labor hours as its activity index, the standard manufacturing overhead cost per gallon of Xonic Tonic is $10 ($5×2 hours)$10 ($5×2 hours).

TOTAL STANDARD COST PER UNIT After a company has established the standard quantity and price per unit of product, it can determine the total standard cost. The total standard cost per unit is the sum of the standard costs of direct materials, direct labor, and manufacturing overhead. The total standard cost per gallon of Xonic Tonic is $52, as shown on the following standard cost card.

ILLUSTRATION 23-7 Standard cost per gallon of Xonic Tonic

The company prepares a standard cost card for each product. This card provides the basis for determining variances from standards.

DO IT! 1

Standard Costs

Ridette Inc. accumulated the following standard cost data concerning product Cty31.

1. Direct materials per unit: 1.5 pounds at $4 per pound

2. Direct labor per unit: 0.25 hours at $13 per hour.

3. Manufacturing overhead: allocated based on direct labor hours at a predetermined rate of $15.60 per direct labor hour.

Compute the standard cost of one unit of product Cty31.

Action Plan

✓ Know that standard costs are predetermined unit costs.

✓ To establish the standard cost of producing a product, establish the standard for each manufacturing cost element—direct materials, direct labor, and manufacturing overhead.

✓ Compute the standard cost for each element from the standard price to be paid and the standard quantity to be used.

SOLUTION

Manufacturing Cost Element	Standard Quantity	×	Standard Price	=	Standard Cost
Direct materials	1.5 pounds		$ 4.00		$ 6.00
Direct labor	0.25 hours		$13.00		3.25
Manufacturing overhead	0.25 hours		$15.60		3.90
Total					$13.15

Related exercise material: BE23-2, BE23-3, E23-1, E23-2, E23-3, and DO IT! 23-1.

LEARNING OBJECTIVE 2

Determine direct materials variances.

ANALYZING AND REPORTING VARIANCES

One of the major management uses of standard costs is to identify variances from standards. Variances are the differences between total actual costs and total standard costs.

To illustrate, assume that in producing 1,000 gallons of Xonic Tonic in the month of June, Xonic incurred the following costs.

Direct materials	$13,020
Direct labor	31,080
Variable overhead	6,500
Fixed overhead	4,400
Total actual costs	$55,000

ILLUSTRATION 23-8 Actual production costs

Companies determine total standard costs by multiplying the units produced by the standard cost per unit. The total standard cost of Xonic Tonic is $52,000 (1,000 gallons×$52)$52,000 (1,000 gallons×$52). Thus, the total variance is $3,000, as shown below.

Actual costs	$55,000
Less: Standard costs	52,000
Total variance	$ 3,000

ILLUSTRATION 23-9 Computation of total variance

Note that the variance is expressed in total dollars, not on a per unit basis.

When actual costs exceed standard costs, the variance is unfavorable. The $3,000 variance in June for Xonic Tonic is unfavorable. An unfavorable variance has a negative connotation. It suggests that the company paid too much for one or more of the manufacturing cost elements or that it used the elements inefficiently.

If actual costs are less than standard costs, the variance is favorable. A favorable variance has a positive connotation. It suggests efficiencies in incurring manufacturing costs and in using direct materials, direct labor, and manufacturing overhead.

However, be careful: A favorable variance could be obtained by using inferior materials. In printing wedding invitations, for example, a favorable variance could result from using an inferior grade of paper. Or, a favorable variance might be achieved in installing tires on an automobile assembly line by tightening only half of the lug bolts. A variance is not favorable if the company has sacrificed quality control standards.

To interpret a variance, you must analyze its components. A variance can result from differences related to the cost of materials, labor, or overhead. Illustration 23-10 shows that the total variance is the sum of the materials, labor, and overhead variances.

Materials Variance+Labor Variance+Overhead Variance=Total VarianceMaterials Variance+Labor Variance+Overhead Variance=Total Variance ILLUSTRATION 23-10 Components of total variance

In the following discussion, you will see that the materials variance and the labor variance are the sum of variances resulting from price differences and quantity differences. Illustration 23-11 shows a format for computing the price and quantity variances.

ILLUSTRATION 23-11 Breakdown of materials or labor variance into price and quantity variances

Note that the left side of the matrix is actual cost (actual quantity times actual price). The right hand is standard cost (standard quantity times standard price). The only additional element you need in order to compute the price and quantity variances is the middle element, the actual quantity at the standard price.

ALTERNATIVE TERMINOLOGY

In business, the term variance is also used to indicate differences between total budgeted and total actual costs.

DIRECT MATERIALS VARIANCES

Part of Xonic's total variance of $3,000 is due to a materials variance. In completing the order for 1,000 gallons of Xonic Tonic, the company used 4,200 pounds of direct materials. The direct materials were purchased at a price of $3.10 per unit. From Illustration 23-3 , we know that Xonic's standards require it to use 4 pounds of materials per gallon produced, so it should have only used 4,000 (4×1,000)4,000 (4×1,000) pounds of direct materials to produce 1,000 gallons. Illustration 23-2 shows that the standard cost of each pound of direct materials is $3 instead of the $3.10 actually paid. Illustration 23-12 shows that the total materials variance is computed as the difference between the amount paid (actual quantity times actual price) and the amount that should have been paid based on standards (standard quantity times standard price of materials).

Actual QuantityStandard QuantityTotal Materials×Actual Price−×Standard Price=Variance(AQ)×(AP)(SQ)×(SP)(TMV)(4,200×$3.10)−(4,000×$3.00)=$1,020 UActual QuantityStandard QuantityTotal Materials×Actual Price−×Standard Price=Variance(AQ)×(AP)(SQ)×(SP)(TMV)(4,200×$3.10)−(4,000×$3.00)=$1,020 U ILLUSTRATION 23-12 Formula for total materials variance

Thus, for Xonic, the total materials variance is $1,020 ($13,020−$12,000)$1,020 ($13,020−$12,000) unfavorable.

The total materials variance could be caused by differences in the price paid for the materials or by differences in the amount of materials used. Illustration 23-13 shows that the total materials variance is the sum of the materials price variance and the materials quantity variance.

Materials Price Variance+Materials Quantity Variance=Total Materials VarianceMaterials Price Variance+Materials Quantity Variance=Total Materials Variance ILLUSTRATION 23-13 Components of total materials variance

The materials price variance results from a difference between the actual price and the standard price. Illustration 23-14 shows that the materials price variance is computed as the difference between the actual amount paid (actual quantity of materials times actual price) and the standard amount that should have been paid for the materials used (actual quantity of materials times standard price). 1

Actual QuantityActual QuantityMaterials Price×Actual Price−×Standard Price=Variance(AQ)×(AP)(AQ)×(SP)(MPV)(4,200×$3.10)−(4,200×$3.00)=$420 UActual QuantityActual QuantityMaterials Price×Actual Price−×Standard Price=Variance(AQ)×(AP)(AQ)×(SP)(MPV)(4,200×$3.10)−(4,200×$3.00)=$420 U ILLUSTRATION 23-14 Formula for materials price variance

For Xonic, the materials price variance is $420 ($13,020−$12,600)$420 ($13,020−$12,600) unfavorable.

The price variance can also be computed by multiplying the actual quantity purchased by the difference between the actual and standard price per unit. The computation in this case is 4,200×($3.10−$3.00)=$420 U4,200×($3.10−$3.00)=$420 U.

As seen in Illustration 23-13 , the other component of the materials variance is the quantity variance. The quantity variance results from differences between the amount of material actually used and the amount that should have been used. As shown in Illustration 23-15 , the materials quantity variance is computed as the difference between the standard cost of the actual quantity (actual quantity times standard price) and the standard cost of the amount that should have been used (standard quantity times standard price for materials).

Actual QuantityStandard QuantityMaterials Quantity×Standard Price−×Standard Price=Variance(AQ)×(SP)(SQ)×(SP)(MQV)(4,200×$3.00)−(4,000×$3.00)=$600 UActual QuantityStandard QuantityMaterials Quantity×Standard Price−×Standard Price=Variance(AQ)×(SP)(SQ)×(SP)(MQV)(4,200×$3.00)−(4,000×$3.00)=$600 U ILLUSTRATION 23-15 Formula for materials quantity variance

Thus, for Xonic, the materials quantity variance is $600 ($12,600−$12,000)$600 ($12,600−$12,000) unfavorable.

The quantity variance can also be computed by applying the standard price to the difference between actual and standard quantities used. The computation in this example is $3.00×(4,200−4,000)=$600 U$3.00×(4,200−4,000)=$600 U.

The total materials variance of $1,020 U, therefore, consists of the following.

Materials price variance	$ 420 U
Materials quantity variance	600 U
Total materials variance	$1,020 U

ILLUSTRATION 23-16 Summary of materials variances

Companies sometimes use a matrix to analyze a variance. When the matrix is used, a company computes the amounts using the formulas for each cost element first and then computes the variances. Illustration 23-17 shows the completed matrix for the direct materials variance for Xonic. The matrix provides a convenient structure for determining each variance.

ILLUSTRATION 23-17 Matrix for direct materials variances

DECISION TOOLS

The materials price and materials quantity variances help managers determine if they have met their price and quantity objectives regarding materials.

▼ HELPFUL HINT

The alternative formula is:

AQ×AP−SP=MPVAQ×AP−SP=MPV

▼ HELPFUL HINT

The alternative formula is:

SP×AQ−SQ=MQVSP×AQ−SQ=MQV

Causes of Materials Variances

What are the causes of a variance? The causes may relate to both internal and external factors. The investigation of a materials price variance usually begins in the purchasing department. Many factors affect the price paid for raw materials. These include availability of quantity and cash discounts, the quality of the materials requested, and the delivery method used. To the extent that these factors are considered in setting the price standard, the purchasing department is responsible for any variances.

However, a variance may be beyond the control of the purchasing department. Sometimes, for example, prices may rise faster than expected. Moreover, actions by groups over which the company has no control, such as the OPEC nations' oil price increases, may cause an unfavorable variance. For example, during a recent year, Kraft Foods and Kellogg Company both experienced unfavorable materials price variances when the cost of dairy and wheat products jumped unexpectedly. There are also times when a production department may be responsible for the price variance. This may occur when a rush order forces the company to pay a higher price for the materials.

The starting point for determining the cause(s) of a significant materials quantity variance is in the production department. If the variances are due to inexperienced workers, faulty machinery, or carelessness, the production department is responsible. However, if the materials obtained by the purchasing department were of inferior quality, then the purchasing department is responsible.

DO IT! 2

Direct Materials Variances

The standard cost of Wonder Walkers includes two units of direct materials at $8.00 per unit. During July, the company buys 22,000 units of direct materials at $7.50 and uses those materials to produce 10,000 Wonder Walkers. Compute the total, price, and quantity variances for materials.

Action Plan

Use the formulas for computing each of the materials variances:

✓ Total materials variance=(AQ×AP)−(SQ×SP)Total materials variance=(AQ×AP)−(SQ×SP)

✓ Materials price variance=(AQ×AP)−(AQ×SP)Materials price variance=(AQ×AP)−(AQ×SP)

✓ Materials quantity variance=(AQ×SP)−(SQ×SP)Materials quantity variance=(AQ×SP)−(SQ×SP)

SOLUTION

Standard quantity=10,000×2Standard quantity=10,000×2

Substituting amounts into the formulas, the variances are:

Total materials variance=(22,000×$7.50)−(20,000×$8.00)=$5,000 unfavorableTotal materials variance=(22,000×$7.50)−(20,000×$8.00)=$5,000 unfavorable

Materials price variance=(22,000×$7.50)−(22,000×$8.00)=$11,000 favorableMaterials price variance=(22,000×$7.50)−(22,000×$8.00)=$11,000 favorable

Materials quantity variance=(22,000×$8.00)−(20,000×$8.00)=$16,000 unfavorableMaterials quantity variance=(22,000×$8.00)−(20,000×$8.00)=$16,000 unfavorable

Related exercise material: BE23-4, E23-5, and DO IT! 23-2.

LEARNING OBJECTIVE 3

Determine direct labor and total manufacturing overhead variances.

DIRECT LABOR VARIANCES

The process of determining direct labor variances is the same as for determining the direct materials variances. In completing the Xonic Tonic order, the company incurred 2,100 direct labor hours at an average hourly rate of $14.80. The standard hours allowed for the units produced were 2,000 hours (1,000 gallons×2 hours)2,000 hours (1,000 gallons×2 hours). The standard labor rate was $15 per hour.

The total labor variance is the difference between the amount actually paid for labor versus the amount that should have been paid. Illustration 23-18 shows that the total labor variance is computed as the difference between the amount actually paid for labor (actual hours times actual rate) and the amount that should have been paid (standard hours times standard rate for labor).

Actual HoursStandard HoursTotal Labor×Actual Rate−×Standard Rate=Variance(AH)×(AR)(SH)×(SR)(TLV)(2,100×$14.80)−(2,000×$15.00)=$1,080 UActual HoursStandard HoursTotal Labor×Actual Rate−×Standard Rate=Variance(AH)×(AR)(SH)×(SR)(TLV)(2,100×$14.80)−(2,000×$15.00)=$1,080 U ILLUSTRATION 23-18 Formula for total labor variance

The total labor variance is $1,080 ($31,080−$30,000)$1,080 ($31,080−$30,000) unfavorable.

The total labor variance is caused by differences in the labor rate or differences in labor hours. Illustration 23-19 shows that the total labor variance is the sum of the labor price variance and the labor quantity variance.

Labor Price Variance+Labor Quantity Variance=Total Labor VarianceLabor Price Variance+Labor Quantity Variance=Total Labor Variance ILLUSTRATION 23-19 Components of total labor variance

The labor price variance results from the difference between the rate paid to workers versus the rate that was supposed to be paid. Illustration 23-20 shows that the labor price variance is computed as the difference between the actual amount paid (actual hours times actual rate) and the amount that should have been paid for the number of hours worked (actual hours times standard rate for labor).

Actual HoursActual HoursLabor Price×Actual Rate−×Standard Rate=Variance(AH)×(AR)(AH)×(SR)(LPV)(2,100×$14.80)−(2,100×$15.00)=$420 FActual HoursActual HoursLabor Price×Actual Rate−×Standard Rate=Variance(AH)×(AR)(AH)×(SR)(LPV)(2,100×$14.80)−(2,100×$15.00)=$420 F ILLUSTRATION 23-20 Formula for labor price variance

For Xonic, the labor price variance is $420 ($31,080−$31,500)$420 ($31,080−$31,500) favorable.

The labor price variance can also be computed by multiplying actual hours worked by the difference between the actual pay rate and the standard pay rate. The computation in this example is 2,100×($15.00−$14.80)=$420 F2,100×($15.00−$14.80)=$420 F.

The other component of the total labor variance is the labor quantity variance. The labor quantity variance results from the difference between the actual number of labor hours and the number of hours that should have been worked for the quantity produced. Illustration 23-21 shows that the labor quantity variance is computed as the difference between the amount that should have been paid for the hours worked (actual hours times standard rate) and the amount that should have been paid for the amount of hours that should have been worked (standard hours times standard rate for labor).

Actual HoursStandard HoursLabor Quantity×Standard Rate−×Standard Rate=Variance(AH)×(SR)(SH)×(SR)(LQV)(2,100×$15.00)−(2,000×$15.00)=$1,500 UActual HoursStandard HoursLabor Quantity×Standard Rate−×Standard Rate=Variance(AH)×(SR)(SH)×(SR)(LQV)(2,100×$15.00)−(2,000×$15.00)=$1,500 U ILLUSTRATION 23-21 Formula for labor quantity variance

Thus, for Xonic, the labor quantity variance is $1,500 ($31,500−$30,000)$1,500 ($31,500−$30,000) unfavorable.

The same result can be obtained by multiplying the standard rate by the difference between actual hours worked and standard hours allowed. In this case, the computation is $15.00×(2,100−2,000)=$1,500 U$15.00×(2,100−2,000)=$1,500 U.

The total direct labor variance of $1,080 U, therefore, consists of the following.

Labor price variance	$ 420 F
Labor quantity variance	1,500 U
Total direct labor variance	$1,080 U

ILLUSTRATION 23-22 Summary of labor variances

These results can also be obtained from the matrix in Illustration 23-23 .

ILLUSTRATION 23-23 Matrix for direct labor variances

DECISION TOOLS

Labor price and labor quantity variances help managers to determine if they have met their price and quantity objectives regarding labor.

▼ HELPFUL HINT

The alternative formula is:

AH×AR−SR=LPVAH×AR−SR=LPV

▼ HELPFUL HINT

The alternative formula is:

SR×AH−SH=LQVSR×AH−SH=LQV

Causes of Labor Variances

Labor price variances usually result from two factors: (1) paying workers different wages than expected, and (2) misallocation of workers. In companies where pay rates are determined by union contracts, labor price variances should be infrequent. When workers are not unionized, there is a much higher likelihood of such variances. The responsibility for these variances rests with the manager who authorized the wage change.

Misallocation of the workforce refers to using skilled workers in place of unskilled workers and vice versa. The use of an inexperienced worker instead of an experienced one will result in a favorable price variance because of the lower pay rate of the unskilled worker. An unfavorable price variance would result if a skilled worker were substituted for an inexperienced one. The production department generally is responsible for labor price variances resulting from misallocation of the workforce.

Labor quantity variances relate to the efficiency of workers. The cause of a quantity variance generally can be traced to the production department. The causes of an unfavorable variance may be poor training, worker fatigue, faulty machinery, or carelessness. These causes are the responsibility of the production department. However, if the excess time is due to inferior materials, the responsibility falls outside the production department.

MANUFACTURING OVERHEAD VARIANCES

The total overhead variance is the difference between the actual overhead costs and overhead costs applied based on standard hours allowed for the amount of goods produced. As indicated in Illustration 23-8 (page 1125), Xonic incurred overhead costs of $10,900 to produce 1,000 gallons of Xonic Tonic in June. The computation of the actual overhead is comprised of a variable and a fixed component. Illustration 23-24 (page 1132) shows this computation.

Variable overhead	$ 6,500
Fixed overhead	4,400
Total actual overhead	$10,900

ILLUSTRATION 23-24 Actual overhead costs

To find the total overhead variance in a standard costing system, we determine the overhead costs applied based on standard hours allowed. Standard hours allowed are the hours that should have been worked for the units produced. Overhead costs for Xonic Tonic are applied based on direct labor hours. Because it takes two hours of direct labor to produce one gallon of Xonic Tonic, for the 1,000‐gallon Xonic Tonic order, the standard hours allowed are 2,000 hours (1,000 gallons×2 hours)2,000 hours (1,000 gallons×2 hours). We then apply the predetermined overhead rate to the 2,000 standard hours allowed.

Recall from Illustration 23-6 (page 1124) that the amount of budgeted overhead costs at normal capacity of $132,000 was divided by normal capacity of 26,400 direct labor hours, to arrive at a predetermined overhead rate of $5 ($132,000÷26,400)$5 ($132,000÷26,400). The predetermined rate of $5 is then multiplied by the 2,000 standard hours allowed, to determine the overhead costs applied.

Illustration 23-25 shows the formula for the total overhead variance and the calculation for Xonic for the month of June.

Actual Overhead	−	Overhead Applied *	=	Total Overhead Variance
$10,900	−	$10,000	=	$900 U
($6,500 + $4,400)		($5 × 2,000 hours)

* Based on standard hours allowed.

ILLUSTRATION 23-25 Formula for total overhead variance

Thus, for Xonic, the total overhead variance is $900 unfavorable.

The overhead variance is generally analyzed through a price and a quantity variance. (These computations are discussed in more detail in advanced courses.) The name usually given to the price variance is the overhead controllable variance; the quantity variance is referred to as the overhead volume variance. Appendix 23B discusses how the total overhead variance can be broken down into these two variances.

DECISION TOOLS

The total manufacturing overhead variance helps managers to determine if they have met their objectives regarding manufacturing overhead.

Causes of Manufacturing Overhead Variances

One reason for an overhead variance relates to over‐ or underspending on overhead items. For example, overhead may include indirect labor for which a company paid wages higher than the standard labor price allowed. Or, the price of electricity to run the company's machines increased, and the company did not anticipate this additional cost. Companies should investigate any spending variances to determine whether they will continue in the future. Generally, the responsibility for these variances rests with the production department.

The overhead variance can also result from the inefficient use of overhead. For example, because of poor maintenance, a number of the manufacturing machines are experiencing breakdowns on a consistent basis, leading to reduced production. Or, the flow of materials through the production process is impeded because of a lack of skilled labor to perform the necessary production tasks, due to a lack of planning. In both of these cases, the production department is responsible for the cause of these variances. On the other hand, overhead can also be underutilized because of a lack of sales orders. When the cause is a lack of sales orders, the responsibility rests outside the production department. For example, at one point Chrysler experienced a very significant unfavorable overhead variance because plant capacity was maintained at excessively high levels, due to overly optimistic sales forecasts.

PEOPLE, PLANET, AND PROFIT INSIGHT

Starbucks

What's Brewing at Starbucks?

It's easy for a company to say it's committed to corporate social responsibility. But Starbucks actually spells out measurable goals. Recently, the company published its annual Global Responsibility Report in which it describes its goals, achievements, and even its shortcomings related to corporate social responsibility. For example, Starbucks achieved its goal of getting more than 50% of its electricity from renewable sources. It also has numerous goals related to purchasing coffee from sources that are certified as responsibly grown and ethically traded; providing funds for loans to coffee farmers; and fostering partnerships with Conservation International to provide training to farmers on ecologically friendly growing.

The report also candidly explains that the company did not meet its goal to cut energy consumption by 25%. It also fell far short of its goal of getting customers to reuse their cups. In those instances where it didn't achieve its goals, Starbucks set new goals and described steps it would take to achieve them. You can view the company's Global Responsibility Report at www.starbucks.com.

Source: “Starbucks Launches 10th Global Responsibility Report,” Business Wire (April 18, 2011).

What implications does Starbucks' commitment to corporate social responsibility have for the standard cost of a cup of coffee? (Go to WileyPLUS for this answer and additional questions.)

DO IT! 3

Labor and Manufacturing Overhead Variances

The standard cost of Product YY includes 3 hours of direct labor at $12.00 per hour. The predetermined overhead rate is $20.00 per direct labor hour. During July, the company incurred 3,500 hours of direct labor at an average rate of $12.40 per hour and $71,300 of manufacturing overhead costs. It produced 1,200 units.

(a) Compute the total, price, and quantity variances for labor. (b) Compute the total overhead variance.

Action Plan

✓ Use the formulas for computing each of the variances:

1. Total labor variance=(AH×AR)−(SH×SR)Total labor variance=(AH×AR)−(SH×SR)

2. Labor price variance=(AH×AR)−(AH×SR)Labor price variance=(AH×AR)−(AH×SR)

3. Labor quantity variance=(AH×SR)−(SH×SR)Labor quantity variance=(AH×SR)−(SH×SR)

4. Total overhead variance= Actual overhead−Overhead appliedTotal overhead variance= Actual overhead−Overhead applied *

* Based on standard hours allowed.

SOLUTION

Substituting amounts into the formulas, the variances are:

1. Total labor variance=(3,500×$12.40)−(3,600×$12.00)=$200 unfavorableTotal labor variance=(3,500×$12.40)−(3,600×$12.00)=$200 unfavorable

2. Labor price variance=(3,500×$12.40)−(3,500×$12.00)=$1,400 unfavorableLabor price variance=(3,500×$12.40)−(3,500×$12.00)=$1,400 unfavorable

3. Labor quantity variance=(3,500×$12.00)−(3,600×$12.00)=$1,200 favorableLabor quantity variance=(3,500×$12.00)−(3,600×$12.00)=$1,200 favorable

4. Total overhead variance=$71,300−$72,000Total overhead variance=$71,300−$72,000 * =$700 favorable=$700 favorable

* (1,200×3 hours)×$20.00(1,200×3 hours)×$20.00

Related exercise material: BE23-5, BE23-6, E23-4, E23-6, E23-7, E23-8, E23-11, and DO IT! 23-3.

LEARNING OBJECTIVE 4

Prepare variance reports and balanced scorecards.

REPORTING VARIANCES

All variances should be reported to appropriate levels of management as soon as possible. The sooner managers are informed, the sooner they can evaluate problems and take corrective action.

The form, content, and frequency of variance reports vary considerably among companies. One approach is to prepare a weekly report for each department that has primary responsibility for cost control. Under this approach, materials price variances are reported to the purchasing department, and all other variances are reported to the production department that did the work. The following report for Xonic, with the materials for the Xonic Tonic order listed first, illustrates this approach.

XONIC Variance Report—Purchasing Department For Week Ended June 8, 2017
Type of Materials	Quantity Purchased	Actual Price	Standard Price	Price Variance	Explanation
X100	4,200 lbs.	$3.10	$3.00	$ 420 U	Rush order
X142	1,200 units	2.75	2.80	60 F	Quantity discount
A85	600 doz.	5.20	5.10	60 U	Regular supplier on strike
Total price variance			$420 U

ILLUSTRATION 23-26 Materials price variance report

The explanation column is completed after consultation with the purchasing department manager.

Variance reports facilitate the principle of “management by exception” explained in Chapter 22 . For example, the vice president of purchasing can use the report shown above to evaluate the effectiveness of the purchasing department manager. Or, the vice president of production can use production department variance reports to determine how well each production manager is controlling costs. In using variance reports, top management normally looks for significant variances. These may be judged on the basis of some quantitative measure, such as more than 10% of the standard or more than $1,000.

INCOME STATEMENT PRESENTATION OF VARIANCES

In income statements prepared for management under a standard cost accounting system, cost of goods sold is stated at standard cost and the variances are disclosed separately. Unfavorable variances increase cost of goods sold, while favorable variances decrease cost of goods sold. Illustration 23-27 shows the presentation of variances in an income statement. This income statement is based on the production and sale of 1,000 units of Xonic Tonic at $70 per unit. It also assumes selling and administrative costs of $3,000. Observe that each variance is shown, as well as the total net variance. In this example, variations from standard costs reduced net income by $3,000.

XONIC Income Statement For the Month Ended June 30, 2017
Sales revenue		$70,000
Cost of goods sold (at standard)		52,000
Gross profit (at standard)		18,000
Variances
Materials price	$ 420 U
Materials quantity	600 U
Labor price	420 F
Labor quantity	1,500 U
Overhead	900 U
Total variance unfavorable		3,000
Gross profit (actual)		15,000
Selling and administrative expenses		3,000
Net income		$12,000

ILLUSTRATION 23-27 Variances in income statement for management

Standard costs may be used in financial statements prepared for stockholders and other external users. The costing of inventories at standard costs is in accordance with generally accepted accounting principles when there are no significant differences between actual costs and standard costs. Hewlett‐Packard and Jostens, Inc., for example, report their inventories at standard costs. However, if there are significant differences between actual and standard costs, the financial statements must report inventories and cost of goods sold at actual costs.

It is also possible to show the variances in an income statement prepared in the variable costing (CVP) format. To do so, it is necessary to analyze the overhead variances into variable and fixed components. This type of analysis is explained in cost accounting textbooks.

BALANCED SCORECARD

Financial measures (measurement of dollars), such as variance analysis and return on investment (ROI), are useful tools for evaluating performance. However, many companies now supplement these financial measures with nonfinancial measures to better assess performance and anticipate future results. For example, airlines like Delta and United use capacity utilization as an important measure to understand and predict future performance. Companies that publish the New York Times and the Chicago Tribune newspapers use circulation figures as another measure by which to assess performance. Penske Automotive Group, the owner of 300 dealerships, rewards executives for meeting employee retention targets. Illustration 23-28 lists some key nonfinancial measures used in various industries.

ILLUSTRATION 23-28 Nonfinancial measures used in various industries

Most companies recognize that both financial and nonfinancial measures can provide useful insights into what is happening in the company. As a result, many companies now use a broad‐based measurement approach, called the balanced scorecard, to evaluate performance. The balanced scorecard incorporates financial and nonfinancial measures in an integrated system that links performance measurement with a company's strategic goals. Nearly 50% of the largest companies in the United States, including Unilever, Chase, and Wal‐Mart Stores Inc., are using the balanced scorecard approach.

The balanced scorecard evaluates company performance from a series of “perspectives.” The four most commonly employed perspectives are as follows.

1. The financial perspective is the most traditional view of the company. It employs financial measures of performance used by most firms.

2. The customer perspective evaluates the company from the viewpoint of those people who buy its products or services. This view compares the company to competitors in terms of price, quality, product innovation, customer service, and other dimensions.

3. The internal process perspective evaluates the internal operating processes critical to success. All critical aspects of the value chain—including product development, production, delivery, and after‐sale service—are evaluated to ensure that the company is operating effectively and efficiently.

4. The learning and growth perspective evaluates how well the company develops and retains its employees. This would include evaluation of such things as employee skills, employee satisfaction, training programs, and information dissemination.

Within each perspective, the balanced scorecard identifies objectives that contribute to attainment of strategic goals. Illustration 23-29 shows examples of objectives within each perspective.

ILLUSTRATION 23-29 Examples of objectives within the four perspectives of balanced scorecard

The objectives are linked across perspectives in order to tie performance measurement to company goals. The financial‐perspective objectives are normally set first, and then objectives are set in the other perspectives in order to accomplish the financial goals.

For example, within the financial perspective, a common goal is to increase profit per dollars invested as measured by ROI. In order to increase ROI, a customer‐perspective objective might be to increase customer satisfaction as measured by the percentage of customers who would recommend the product to a friend. In order to increase customer satisfaction, an internal‐process‐perspective objective might be to increase product quality as measured by the percentage of defect‐free units. Finally, in order to increase the percentage of defect‐free units, the learning‐and‐growth‐perspective objective might be to reduce factory employee turnover as measured by the percentage of employees leaving in under one year.

Illustration 23-30 illustrates this linkage across perspectives.

ILLUSTRATION 23-30 Linked process across balanced scorecard perspectives

Through this linked process, the company can better understand how to achieve its goals and what measures to use to evaluate performance.

In summary, the balanced scorecard does the following:

1. Employs both financial and nonfinancial measures. (For example, ROI is a financial measure; employee turnover is a nonfinancial measure.)

2. Creates linkages so that high‐level corporate goals can be communicated all the way down to the shop floor.

3. Provides measurable objectives for nonfinancial measures such as product quality, rather than vague statements such as “We would like to improve quality.”

4. Integrates all of the company's goals into a single performance measurement system, so that an inappropriate amount of weight will not be placed on any single goal.

SERVICE COMPANY INSIGHT

United Airlines

It May Be Time to Fly United Again

Many of the benefits of a balanced scorecard approach are evident in the improved operations at United Airlines. At the time it filed for bankruptcy, United had a reputation for some of the worst service in the airline business. But when Glenn Tilton took over as United's chief executive officer, he recognized that things had to change.

He implemented an incentive program that allows all of United's 63,000 employees to earn a bonus of 2.5% or more of their wages if the company “exceeds its goals for on‐time flight departures and for customer intent to fly United again.” After instituting this program, the company's on‐time departures were among the best, its customer complaints were reduced considerably, and the number of customers who said that they would fly United again was at its highest level ever.

Sources: Susan Carey, “Friendlier Skies: In Bankruptcy, United Airlines Forges a Path to Better Service,” Wall Street Journal (June 15, 2004); and Emre Serpen, “More to Maintain,” Airline Business (November 2012), pp. 38–40.

Which of the perspectives of a balanced scorecard were the focus of United's CEO? (Go to WileyPLUS for this answer and additional questions.)

DO IT! 4

Reporting Variances

Polar Vortex Corporation experienced the following variances: materials price $250 F, materials quantity $1,100 F, labor price $700 U, labor quantity $300 F, and overhead $800 F. Sales revenue was $102,700, and cost of goods sold (at standard) was $61,900. Determine the actual gross profit.

Action Plan

✓ Gross profit at standard is sales revenue less cost of goods sold at standard.

✓ Adjust standard gross profit by adding a net favorable variance or subtracting a net unfavorable variance.

SOLUTION

Sales revenue		$102,700
Cost of goods sold (at standard)		61,900
Standard gross profit		40,800
Variances
Materials price	$ 250 F
Materials quantity	1,100 F
Labor price	700 U
Labor quantity	300 F
Overhead	800 F
Total variance favorable		1,750
Gross profit (actual)		$ 42,550

Related exercise material: E23-10, E23-14, E23-15, and DO IT! 23-4.

USING DECISION TOOLS—STARBUCKS

Starbucks faces many situations where it needs to apply the decision tools learned in this chapter. Assume that during the past month, Starbucks produced 10,000 50‐pound sacks of dark roast Sumatra coffee beans, with the standard cost for one 50‐pound sack of dark roast Sumatra as follows.

	Standard
Manufacturing Cost Elements	Quantity	×	Price	=	Cost
Direct materials (unroasted beans)	60 lbs.	×	$ 2.00	=	$120.00
Direct labor	0.25 hours	×	$16.00	=	4.00
Overhead	0.25 hours	×	$48.00	=	12.00
					$136.00

During the month, the following transactions occurred in manufacturing the 10,000 50‐pound sacks of Sumatra coffee.

1. Purchased 620,000 pounds of unroasted beans at a price of $1.90 per pound for a total cost of $1,178,000.

2. All materials purchased during the period were used to make coffee during the period.

3. 2,300 direct labor hours were worked at a total labor cost of $36,340 (an average hourly rate of $15.80).

4. Variable manufacturing overhead incurred was $34,600, and fixed overhead incurred was $84,000.

The manufacturing overhead rate of $48.00 is based on a normal capacity of 2,600 direct labor hours. The total budget at this capacity is $83,980 fixed and $40,820 variable.

INSTRUCTIONS

Determine whether Starbucks met its price and quantity objectives relative to materials, labor, and overhead.

SOLUTION

To determine whether Starbucks met its price and quantity objectives, compute the total variance and the variances for direct materials and direct labor, and calculate the total variance for manufacturing overhead.

Total Variance
Actual cost incurred:
Direct materials	$1,178,000
Direct labor	36,340
Overhead	118,600
Total actual costs	1,332,940
Less: Standard cost (10,000 × $136.00)	1,360,000
Total variance	$ 27,060	F

Direct Materials Variances
Total	=	$1,178,000 (620,000 × $1.90)	−	$1,200,000 (600,000 × $2.00)	=	$22,000 F
Price	=	$1,178,000 (620,000 × $1.90)	−	$1,240,000 (620,000 × $2.00)	=	$62,000 F
Quantity	=	$1,240,000 (620,000 × $2.00)	−	$1,200,000 (600,000 × $2.00)	=	$40,000 U

Direct Labor Variances
Total	=	$36,340 (2,300 × $15.80)	−	$40,000 (2,500 * × $16.00)	=	$ 3,660 F
Price	=	$36,340 (2,300 × $15.80)	−	$36,800 (2,300 × $ 16.00)	=	$ 460 F
Quantity	=	$36,800 (2,300 × $16.00)	−	$40,000 (2,500 * × $16.00)	=	$ 3,200 F

* 10,000 × .25

Overhead Variance
Total	=	$118,600 ($84,000 + $34,600)	−	$ 120,000 (2,500 × $48)	=	$ 1,400 F

Starbucks' total variance was a favorable $27,060. The total materials, labor, and overhead variances were favorable. The company did have an unfavorable materials quantity variance, but this was outweighed by the favorable materials price variance.

LEARNING OBJECTIVE *5

APPENDIX 23A: Identify the features of a standard cost accounting system.

A standard cost accounting system is a double‐entry system of accounting. In this system, companies use standard costs in making entries, and they formally recognize variances in the accounts. Companies may use a standard cost system with either job order or process costing.

In this appendix, we will explain and illustrate a standard cost, job order cost accounting system. The system is based on two important assumptions:

1. Variances from standards are recognized at the earliest opportunity.

2. The Work in Process account is maintained exclusively on the basis of standard costs.

In practice, there are many variations among standard cost systems. The system described here should prepare you for systems you see in the “real world.”

JOURNAL ENTRIES

We will use the transactions of Xonic to illustrate the journal entries. Note as you study the entries that the major difference between the entries here and those for the job order cost accounting system in Chapter 15 is the variance accounts.

1. Purchase raw materials on account for $13,020 when the standard cost is $12,600.

Raw Materials Inventory	12,600
Materials Price Variance	420
Accounts Payable		13,020
(To record purchase of materials)

Xonic debits the inventory account for actual quantities at standard cost. This enables the perpetual materials records to show actual quantities. Xonic debits the price variance, which is unfavorable, to Materials Price Variance.

2. Incur direct labor costs of $31,080 when the standard labor cost is $31,500.

Factory Labor	31,500
Labor Price Variance		420
Factory Wages Payable		31,080
(To record direct labor costs)

Like the raw materials inventory account, Xonic debits Factory Labor for actual hours worked at the standard hourly rate of pay. In this case, the labor variance is favorable. Thus, Xonic credits Labor Price Variance.

3. Incur actual manufacturing overhead costs of $10,900.

Manufacturing Overhead	10,900
Accounts Payable/Cash/Acc. Depreciation		10,900
(To record overhead incurred)

The controllable overhead variance (see Appendix 23B ) is not recorded at this time. It depends on standard hours applied to work in process. This amount is not known at the time overhead is incurred.

4. Issue raw materials for production at a cost of $12,600 when the standard cost is $12,000.

Work in Process Inventory	12,000
Materials Quantity Variance	600
Raw Materials Inventory		12,600
(To record issuance of raw materials)

Xonic debits Work in Process Inventory for standard materials quantities used at standard prices. It debits the variance account because the variance is unfavorable. The company credits Raw Materials Inventory for actual quantities at standard prices.

5. Assign factory labor to production at a cost of $31,500 when standard cost is $30,000.

Work in Process Inventory	30,000
Labor Quantity Variance	1,500
Factory Labor		31,500
(To assign factory labor to jobs)

Xonic debits Work in Process Inventory for standard labor hours at standard rates. It debits the unfavorable variance to Labor Quantity Variance. The credit to Factory Labor produces a zero balance in this account.

6. Apply manufacturing overhead to production $10,000.

Work in Process Inventory	10,000
Manufacturing Overhead		10,000
(To assign overhead to jobs)

Xonic debits Work in Process Inventory for standard hours allowed multiplied by the standard overhead rate.

7. Transfer completed work to finished goods $52,000.

Finished Goods Inventory	52,000
Work in Process Inventory		52,000
(To record transfer of completed work to finished goods)

In this example, both inventory accounts are at standard cost.

8. Sell the 1,000 gallons of Xonic Tonic for $70,000.

Accounts Receivable	70,000
Cost of Goods Sold	52,000
Sales		70,000
Finished Goods Inventory		52,000
(To record sale of finished goods and the cost of goods sold)

The company debits Cost of Goods Sold at standard cost. Gross profit, in turn, is the difference between sales and the standard cost of goods sold.

9. Recognize unfavorable total overhead variance:

Overhead Variance	900
Manufacturing Overhead		900
(To recognize overhead variances)

Prior to this entry, a debit balance of $900 existed in Manufacturing Overhead. This entry therefore produces a zero balance in the Manufacturing Overhead account. The information needed for this entry is often not available until the end of the accounting period.

LEDGER ACCOUNTS

Illustration 23A-1 shows the cost accounts for Xonic after posting the entries. Note that five variance accounts are included in the ledger. The remaining accounts are the same as those illustrated for a job order cost system in Chapter 15 , in which only actual costs were used.

ILLUSTRATION 23A-1 Cost accounts with variances

▼ HELPFUL HINT

All debit balances in variance accounts indicate unfavorable variances; all credit balances indicate favorable variances.

LEARNING OBJECTIVE *6

APPENDIX 23B: Compute overhead controllable and volume variances.

As indicated in the chapter, the total overhead variance is generally analyzed through a price variance and a quantity variance. The name usually given to the price variance is the overhead controllable variance; the quantity variance is referred to as the overhead volume variance.

OVERHEAD CONTROLLABLE VARIANCE

The overhead controllable variance shows whether overhead costs are effectively controlled. To compute this variance, the company compares actual overhead costs incurred with budgeted costs for the standard hours allowed. The budgeted costs are determined from a flexible manufacturing overhead budget. The concepts related to a flexible budget were discussed in Chapter 22 .

For Xonic, the budget formula for manufacturing overhead is variable manufacturing overhead cost of $3 per hour of labor plus fixed manufacturing overhead costs of $4,400 ($52,800÷12$52,800÷12, per Illustration 23-6 on page 1124). Illustration 23B-1 shows the monthly flexible budget for Xonic.

ILLUSTRATION 23B-1 Flexible budget using standard direct labor hours

As shown, the budgeted costs for 2,000 standard hours are $10,400 ($6,000 variable and $4,400 fixed).

Illustration 23B-2 shows the formula for the overhead controllable variance and the calculation for Xonic at 1,000 units of output (2,000 standard labor hours).

Actual Overhead	−	Overhead Budgeted *	=	Overhead Controllable Variance
$10,900	−	$10,400	=	$500 U
($6,500 + $4,400)		($6,000 + $4,400)
* Based on standard hours allowed.

ILLUSTRATION 23B-2 Formula for overhead controllable variance

The overhead controllable variance for Xonic is $500 unfavorable.

Most controllable variances are associated with variable costs, which are controllable costs. Fixed costs are often known at the time the budget is prepared and are therefore not as likely to deviate from the budgeted amount. In Xonic's case, all of the overhead controllable variance is due to the difference between the actual variable overhead costs ($6,500) and the budgeted variable costs ($6,000).

Management can compare actual and budgeted overhead for each manufacturing overhead cost that contributes to the controllable variance. In addition, management can develop cost and quantity variances for each overhead cost, such as indirect materials and indirect labor.

OVERHEAD VOLUME VARIANCE

The overhead volume variance is the difference between normal capacity hours and standard hours allowed times the fixed overhead rate. The overhead volume variance relates to whether fixed costs were under‐ or overapplied during the year. For example, the overhead volume variance answers the question of whether Xonic effectively used its fixed costs. If Xonic produces less Xonic Tonic than normal capacity would allow, an unfavorable variance results. Conversely, if Xonic produces more Xonic Tonic than what is considered normal capacity, a favorable variance results.

The formula for computing the overhead volume variance is as follows.

FixedOverheadRate×⎛⎜⎝NormalStandardCapacity−HoursHoursAllowed⎞⎟⎠=OverheadVolumeVarianceFixedOverheadRate×(NormalStandardCapacity−HoursHoursAllowed)=OverheadVolumeVarianceILLUSTRATION 23B-3 Formula for overhead volume variance

To illustrate the fixed overhead rate computation, recall that Xonic budgeted fixed overhead cost for the year of $52,800 ( Illustration 23-6 on page 1124). At normal capacity, 26,400 standard direct labor hours are required. The fixed overhead rate is therefore $2 per hour ($52,800÷26,400 hours)$2 per hour ($52,800÷26,400 hours).

Xonic produced 1,000 units of Xonic Tonic in June. The standard hours allowed for the 1,000 gallons produced in June is 2,000 (1,000 gallons×2 hours)2,000 (1,000 gallons×2 hours). For Xonic, normal capacity for June is 1,100, so standard direct labor hours for June at normal capacity is 2,200 (26,400 annual hours÷12 months)2,200 (26,400 annual hours÷12 months). The computation of the overhead volume variance in this case is as follows.

FixedOverheadRate×⎛⎜⎝NormalStandardCapacity−HoursHoursAllowed⎞⎟⎠=OverheadVolumeVariance$2×(2,200−2,000)=$400 UFixedOverheadRate×(NormalStandardCapacity−HoursHoursAllowed)=OverheadVolumeVariance$2×(2,200−2,000)=$400 UILLUSTRATION 23B-4 Computation of overhead volume variance for Xonic

In Xonic's case, a $400 unfavorable volume variance results. The volume variance is unfavorable because Xonic produced only 1,000 gallons rather than the normal capacity of 1,100 gallons in the month of June. As a result, it underapplied fixed overhead for that period.

In computing the overhead variances, it is important to remember the following.

1. Standard hours allowed are used in each of the variances.

2. Budgeted costs for the controllable variance are derived from the flexible budget.

3. The controllable variance generally pertains to variable costs.

4. The volume variance pertains solely to fixed costs.

REVIEW AND PRACTICE

LEARNING OBJECTIVES REVIEW

1. Describe standard costs. Both standards and budgets are predetermined costs. The primary difference is that a standard is a unit amount, whereas a budget is a total amount. A standard may be regarded as the budgeted cost per unit of product.

Standard costs offer a number of advantages. They (a) facilitate management planning, (b) promote greater economy, (c) are useful in setting selling prices, (d) contribute to management control, (e) permit “management by exception,” and (f) simplify the costing of inventories and reduce clerical costs.

The direct materials price standard should be based on the delivered cost of raw materials plus an allowance for receiving and handling. The direct materials quantity standard should establish the required quantity plus an allowance for waste and spoilage.

The direct labor price standard should be based on current wage rates and anticipated adjustments such as COLAs. It also generally includes payroll taxes and fringe benefits. Direct labor quantity standards should be based on required production time plus an allowance for rest periods, cleanup, machine setup, and machine downtime.

For manufacturing overhead, a standard predetermined overhead rate is used. It is based on an expected standard activity index such as standard direct labor hours or standard machine hours.

2. Determine direct materials variances. The formulas for the direct materials variances are as follows.

(Actual quantity×Actual price)−(Standard quantity×Standard price)=Totalmaterialsvariance(Actual quantity×Actual price)−(Actual quantity×Standard price)=Materialspricevariance(Actual quantity×Standard price)−(Standard quantity×Standard price)=Materialsquantityvariance(Actual quantity×Actual price)−(Standard quantity×Standard price)=Totalmaterialsvariance(Actual quantity×Actual price)−(Actual quantity×Standard price)=Materialspricevariance(Actual quantity×Standard price)−(Standard quantity×Standard price)=Materialsquantityvariance

3. Determine direct labor and total manufacturing overhead variances. The formulas for the direct labor variances are as follows.

4. (Actual hours×Actual rate)−(Standard hours×Standard rate)=Totallaborvariance(Actual hours×Actual rate)−(Actual hours×Standard rate)=Laborpricevariance(Actual hours×Standard rate)−(Standard hours×Standard rate)=Laborquantityvariance(Actual hours×Actual rate)−(Standard hours×Standard rate)=Totallaborvariance(Actual hours×Actual rate)−(Actual hours×Standard rate)=Laborpricevariance(Actual hours×Standard rate)−(Standard hours×Standard rate)=LaborquantityvarianceThe formula for the total manufacturing overhead variance is as follows.(Actualoverhead)−⎛⎜

5. ⎜

6. ⎜

7. ⎜⎝Overheadapplied atstandard hoursallowed⎞⎟

8. ⎟

9. ⎟

⎟⎠=Total overheadvariance(Actualoverhead)−(Overheadapplied atstandard hoursallowed)=Total overheadvariance

10. Prepare variance reports and balanced scorecards. Variances are reported to management in variance reports. The reports facilitate management by exception by highlighting significant differences. Under a standard costing system, an income statement prepared for management will report cost of goods sold at standard cost and then disclose each variance separately.

The balanced scorecard incorporates financial and nonfinancial measures in an integrated system that links performance measurement and a company's strategic goals. It employs four perspectives: financial, customer, internal process, and learning and growth. Objectives are set within each of these perspectives that link to objectives within the other perspectives.

11. Identify the features of a standard cost accounting system. In a standard cost accounting system, companies journalize and post standard costs, and they maintain separate variance accounts in the ledger.

12. Compute overhead controllable and volume variances. The total overhead variance is generally analyzed through a price variance and a quantity variance. The name usually given to the price variance is the overhead controllable variance. The quantity variance is referred to as the overhead volume variance.

DECISION TOOLS REVIEW

DECISION CHECKPOINTS	INFO NEEDED FOR DECISION	TOOL TO USE FOR DECISION	HOW TO EVALUATE RESULTS
Has management accomplished its price and quantity objectives regarding materials?	Actual cost and standard cost of materials	Materials price and materials quantity variances	Positive (favorable) variances suggest that price and quantity objectives have been met.
Has management accomplished its price and quantity objectives regarding labor?	Actual cost and standard cost of labor	Labor price and labor quantity variances	Positive (favorable) variances suggest that price and quantity objectives have been met.
Has management accomplished its objectives regarding manufacturing overhead?	Actual cost and standard cost of manufacturing overhead	Total manufacturing overhead variance	Positive (favorable) variances suggest that manufacturing overhead objectives have been met.

GLOSSARY REVIEW

· Balanced scorecard An approach that incorporates financial and nonfinancial measures in an integrated system that links performance measurement and a company's strategic goals.

· Customer perspective A viewpoint employed in the balanced scorecard to evaluate the company from the perspective of those people who buy and use its products or services.

· Direct labor price standard The rate per hour that should be incurred for direct labor.

· Direct labor quantity standard The time that should be required to make one unit of product.

· Direct materials price standard The cost per unit of direct materials that should be incurred.

· Direct materials quantity standard The quantity of direct materials that should be used per unit of finished goods.

· Financial perspective A viewpoint employed in the balanced scorecard to evaluate a company's performance using financial measures.

· Ideal standards Standards based on the optimum level of performance under perfect operating conditions.

· Internal process perspective A viewpoint employed in the balanced scorecard to evaluate the effectiveness and efficiency of a company's value chain, including product development, production, delivery, and after‐sale service.

· Labor price variance The difference between the actual hours times the actual rate and the actual hours times the standard rate for labor.

· Labor quantity variance The difference between actual hours times the standard rate and standard hours times the standard rate for labor.

· Learning and growth perspective A viewpoint employed in the balanced scorecard to evaluate how well a company develops and retains its employees.

· Materials price variance The difference between the actual quantity times the actual price and the actual quantity times the standard price for materials.

· Materials quantity variance The difference between the actual quantity times the standard price and the standard quantity times the standard price for materials.

· Normal capacity The average activity output that a company should experience over the long run.

· Normal standards Standards based on an efficient level of performance that are attainable under expected operating conditions.

· * Overhead controllable variance The difference between actual overhead incurred and overhead budgeted for the standard hours allowed.

· * Overhead volume variance The difference between normal capacity hours and standard hours allowed times the fixed overhead rate.

· * Standard cost accounting system A double‐entry system of accounting in which standard costs are used in making entries, and variances are recognized in the accounts.

· Standard costs Predetermined unit costs which companies use as measures of performance.

· Standard hours allowed The hours that should have been worked for the units produced.

· Standard predetermined overhead rate An overhead rate determined by dividing budgeted overhead costs by an expected standard activity index.

· Total labor variance The difference between actual hours times the actual rate and standard hours times the standard rate for labor.

· Total materials variance The difference between the actual quantity times the actual price and the standard quantity times the standard price of materials.

· Total overhead variance The difference between actual overhead costs and overhead costs applied to work done, based on standard hours allowed.

· Variance The difference between total actual costs and total standard costs.

PRACTICE MULTIPLE-CHOICE QUESTIONS

(LO 1)

1. Standards differ from budgets in that:

(a) budgets but not standards may be used in valuing inventories.

(b) budgets but not standards may be journalized and posted.

(d) only budgets contribute to management planning and control.

(LO 1)

2. Standard costs:

(a) are only imposed by governmental agencies.

(b) are predetermined unit costs which companies use as measures of performance.

(d) All of the above.

(LO 1)

3. The advantages of standard costs include all of the following except:

(a) management by exception may be used.

(b) management planning is facilitated.

(d) management must use a static budget.

(LO 1)

4. Normal standards:

(a) allow for rest periods, machine breakdowns, and setup time.

(b) represent levels of performance under perfect operating conditions.

(d) are more likely than ideal standards to result in unethical practices.

(LO 1)

5. The setting of standards is:

(a) a managerial accounting decision.

(b) a management decision.

(d) preferably set at the ideal level of performance.

(LO 2)

6. Each of the following formulas is correct except:

(a) Labor price variance=(Actual hours×Actual rate)−(Actual hours×Standard rate)Labor price variance=(Actual hours×Actual rate)−(Actual hours×Standard rate).

(b) Total overhead variance=Actual overhead−Overhead appliedTotal overhead variance=Actual overhead−Overhead applied.

(c) Materials price variance=(Actual quantity×Actual price)−(Standard quantity×Standard price)Materials price variance=(Actual quantity×Actual price)−(Standard quantity×Standard price).

(d) Labor quantity variance=(Actual hours×Standard rate)−(Standard hours×Standard rate)Labor quantity variance=(Actual hours×Standard rate)−(Standard hours×Standard rate).

(LO 2)

7. In producing product AA, 6,300 pounds of direct materials were used at a cost of $1.10 per pound. The standard was 6,000 pounds at $1.00 per pound. The direct materials quantity variance is:

(a) $330 unfavorable.

(b) $300 unfavorable.

(d) $630 unfavorable.

(LO 3)

8. In producing product ZZ, 14,800 direct labor hours were used at a rate of $8.20 per hour. The standard was 15,000 hours at $8.00 per hour. Based on these data, the direct labor:

(a) quantity variance is $1,600 favorable.

(b) quantity variance is $1,600 unfavorable.

(d) price variance is $3,000 unfavorable.

(LO 3)

9. Which of the following is correct about the total overhead variance?

(a) Budgeted overhead and overhead applied are the same.

(b) Total actual overhead is composed of variable overhead, fixed overhead, and period costs.

(d) Standard hours allowed for the work done is the measure used in computing the variance.

(LO 3)

10. The formula for computing the total overhead variance is:

(a) actual overhead less overhead applied.

(b) overhead budgeted less overhead applied.

(d) No correct answer is given.

(LO 4)

11. Which of the following is incorrect about variance reports?

(a) They facilitate “management by exception.”

(b) They should only be sent to the top level of management.

(d) They may vary in form, content, and frequency among companies.

(LO 4)

12. In using variance reports to evaluate cost control, management normally looks into:

(a) all variances.

(b) favorable variances only.

(d) both favorable and unfavorable variances that exceed a predetermined quantitative measure such as a percentage or dollar amount.

(LO 4)

13. Generally accepted accounting principles allow a company to:

(a) report inventory at standard cost but cost of goods sold must be reported at actual cost.

(b) report cost of goods sold at standard cost but inventory must be reported at actual cost.

(c) report inventory and cost of goods sold at standard cost as long as there are no significant differences between actual and standard cost.

(d) report inventory and cost of goods sold only at actual costs; standard costing is never permitted.

(LO 4)

14. Which of the following would not be an objective used in the customer perspective of the balanced scorecard approach?

(a) Percentage of customers who would recommend product to a friend.

(b) Customer retention.

(d) Earnings per share.

(LO 5)

*15. Which of the following is incorrect about a standard cost accounting system?

(a) It is applicable to job order costing.

(b) It is applicable to process costing.

(d) It keeps separate accounts for each variance.

(LO 6)

*16. The formula to compute the overhead volume variance is:

(a) Fixed overhead rate×(Standard hours−Actual hours)Fixed overhead rate×(Standard hours−Actual hours).

(b) Fixed overhead rate×(Normal capacity hours−Actual hours)Fixed overhead rate×(Normal capacity hours−Actual hours).

(c) Fixed overhead rate×(Normal capacity hours−Standard hours allowed)Fixed overhead rate×(Normal capacity hours−Standard hours allowed).

(d) (Variable overhead rate+Fixed overhead rate)×(Normal capacity hours−Standard hours allowed)(Variable overhead rate+Fixed overhead rate)×(Normal capacity hours−Standard hours allowed).

SOLUTIONS

1. (c) Budgets are expressed in total amounts, and standards are expressed in unit amounts. The other choices are incorrect because (a) standards, not budgets, may be used in valuing inventories; (b) standards, not budgets, may be journalized and posted; and (d) both budgets and standards contribute to management planning and control.

2. (b) Standard costs are predetermined unit costs which companies use as measures of performance. The other choices are incorrect because (a) only those standard costs that are part of regulations are imposed by governmental agencies, (c) standard costs can be used by all types of companies, and (d) choices (a) and (c) are incorrect.

3. (d) Standard costs are separate from a static budget. The other choices are all advantages of using standard costs.

4. (a) Normal standards allow for rest periods, machine breakdowns, and setup time. The other choices are incorrect because they describe ideal standards, not normal standards.

5. (b) Standards are set by management. The other choices are incorrect because setting standards requires input from (a) managerial accountants and (c) sometimes workers, but the final decision is made by management. Choice (d) is incorrect because setting standards at the ideal level of performance is uncommon because of the perceived negative effect on worker morale.

6. (c) Materials price variance=(Actual quantity×Actual price)−(Actual quantity (not Standard quantity)×Standard price)Materials price variance=(Actual quantity×Actual price)−(Actual quantity (not Standard quantity)×Standard price). The other choices are correct formulas.

7. (b) The direct materials quantity variance is (6,300×$1.00)−(6,000×$1.00)=$300(6,300×$1.00)−(6,000×$1.00)=$300. This variance is unfavorable because more material was used than prescribed by the standard. The other choices are therefore incorrect.

8. (a) The direct labor quantity variance is (14,800×$8)−(15,000×$8)=$1,600(14,800×$8)−(15,000×$8)=$1,600. This variance is favorable because less labor was used than prescribed by the standard. The other choices are therefore incorrect.

9. (d) Standard hours allowed for work done is the measure used in computing the variance. The other choices are incorrect because (a) budgeted overhead is used to calculate the predetermined overhead rate while overhead applied is equal to standard hours allowed times the predetermined overhead rate, (b) overhead is a product cost and does not include period costs, and (c) standard hours allowed, not hours actually worked, are used in computing the overhead variance.

10. (a) Total overhead variance equals actual overhead less overhead applied. The other choices are therefore incorrect.

11. (b) Variance reports should be sent to the level of management responsible for the area in which the variance occurred so it can be remedied as quickly as possible. The other choices are correct statements.

12. (d) In using variance reports to evaluate cost control, management normally looks into both favorable and unfavorable variances that exceed a predetermined quantitative measure such as a percentage or dollar amount. The other choices are therefore incorrect.

13. (c) GAAP allows a company to report both inventory and cost of goods sold at standard cost as long as there are no significant differences between actual and standard cost. The other choices are therefore incorrect.

14. (d) Earnings per share is not an objective used in the customer perspective of the balanced scorecard approach. The other choices are all true statements.

15. (c) A standard cost accounting system reports both favorable and unfavorable variances. The other choices are all correct statements.

16. (c) The formula to compute the overhead volume variance is Fixed overhead rate×(Normal capacity hours−Standard hours allowed)Fixed overhead rate×(Normal capacity hours−Standard hours allowed). The other choices are therefore incorrect.

PRACTICE EXERCISES

Compute materials and labor variances.

(LO 2, 3)

1. Hector Inc., which produces a single product, has prepared the following standard cost sheet for one unit of the product.

Direct materials (6 pounds at $2.50 per pound)	$15.00
Direct labor (3.1 hours at $12.00 per hour)	$37.20

During the month of April, the company manufactures 250 units and incurs the following actual costs.

Direct materials purchased and used (1,600 pounds)	$4,192
Direct labor (760 hours)	$8,740

INSTRUCTIONS

Compute the total, price, and quantity variances for materials and labor.

SOLUTION

1. Total materials variance:

(AQ × AP)	−	(SQ × SP)
(1,600 × $2.62 * )		(1,500 ** × $2.50)
$4,192	−	$3,750	=	$442 U

* $4,192 ÷ 1,600

** 250 × 6

Materials price variance:

(AQ × AP)	−	(AQ × SP)
(1,600 × $2.62)		(1,600 × $2.50)
$4,192	−	$4,000	=	$192 U

Materials quantity variance:

(AQ × SP)	−	(SQ × SP)
(1,600 × $2.50)		(1,500 × $2.50)
$4,000	−	$3,750	=	$250 U

Total labor variance:

(AH × AR)	−	(SH × SR)
(760 × $11.50 * )		(775 ** × $12.00)
$8,740	−	$9,300	=	$560 F

* $8,740 ÷ 760

** 250 × 3.1

Labor price variance:

(AH × AR)	−	(AH × SR)
(760 × $11.50)		(760 × $12.00)
$8,740	−	$9,120	=	$380 F

Labor quantity variance:

(AH × SR)	−	(SH × SR)
(760 × $12.00)		(775 × $12.00)
$9,120	−	$9,300	=	$180 F

Compute overhead variance.

(LO 3)

2. Manufacturing overhead data for the production of Product H by Yamato Company are as follows.

Overhead incurred for 35,000 actual direct labor hours worked	$140,000
Overhead rate (variable $3; fixed $1) at normal capacity of 36,000 direct labor hours	$4
Standard hours allowed for work done	34,000

INSTRUCTIONS

Compute the total overhead variance.

SOLUTION

2. Total overhead variance:

Actual Overhead	−	Overhead Applied
$140,000	−	$136,000	=	$4,000 U
		(34,000 × $4)

PRACTICE PROBLEM

Compute variances.

(LO 2, 3)

Manlow Company makes a cologne called Allure. the standard cost for one bottle of Allure is as follows.

	Standard
Manufacturing Cost Elements	Quantity	×	Price	=	Cost
Direct materials	6 oz.	×	$ 0.90	=	$ 5.40
Direct labor	0.5 hrs.	×	12.00	=	6.00
Manufacturing overhead	0.5 hrs.	×	4.80	=	2.40
					$13.80

During the month, the following transactions occurred in manufacturing 10,000 bottles of Allure.

1. 58,000 ounces of materials were purchased at $1.00 per ounce.

2. All the materials purchased were used to produce the 10,000 bottles of Allure.

3. 4,900 direct labor hours were worked at a total labor cost of $56,350.

4. Variable manufacturing overhead incurred was $15,000 and fixed overhead incurred was $10,400.

The manufacturing overhead rate of $4.80 is based on a normal capacity of 5,200 direct labor hours. The total budget at this capacity is $10,400 fixed and $14,560 variable.

INSTRUCTIONS

(a) Compute the total variance and the variances for direct materials and direct labor elements.

(b) Compute the total variance for manufacturing overhead.

SOLUTION

Total Variance
Actual costs incurred
Direct materials	$ 58,000
Direct labor	56,350
Manufacturing overhead	25,400
	139,750
Standard cost (10,000 × $13.80)	138,000
Total variance	$ 1,750	U

Direct Materials Variances
Total	=	$58,000 (58,000 × $1.00)	−	$54,000 (60,000 * × $0.90)	=	$4,000 U
Price	=	$58,000 (58,000 × $1.00)	−	$52,200 (58,000 × $0.90)	=	$5,800 U
Quantity	=	$52,200 (58,000 × $0.90)	−	$54,000 (60,000 × $0.90)	=	$1,800 F

3. * 10,000 × 6

Direct Labor Variances
Total	=	$56,350 (4,900 × $11.50 * )	−	$60,000 (5,000** × $12.00)	=	$3,650 F
Price	=	$56,350 (4,900 × $11.50)	−	$58,800 (4,900 × $12.00)	=	$2,450 F
Quantity	=	$58,800 (4,900 × $12.00)	−	$60,000 (5,000 × $12.00)	=	$1,200 F

4. * 56,350 ÷ 4,900;

5. ** 10,000 × 0.5

Overhead Variance
Total	=	$25,400 ($15,000 + $10,400)	−	$24,000 (5,000 × $4.80)	=	$1,400 U

WileyPLUS

Brief Exercises, DO IT! Exercises, Exercises, Problems, and many additional resources are available for practice in WileyPLUS.

NOTE: All asterisked Questions, Exercises, and Problems relate to material in the appendices to the chapter.

QUESTIONS

1. (a) “Standard costs are the expected total cost of completing a job.” Is this correct? Explain.

(b) “A standard imposed by a governmental agency is known as a regulation.” Do you agree? Explain.

2. (a) Explain the similarities and differences between standards and budgets.

(b) Contrast the accounting for standards and budgets.

3. Standard costs facilitate management planning. What are the other advantages of standard costs?

4. Contrast the roles of the management accountant and management in setting standard costs.

5. Distinguish between an ideal standard and a normal standard.

6. What factors should be considered in setting (a) the direct materials price standard and (b) the direct materials quantity standard?

7. “The objective in setting the direct labor quantity standard is to determine the aggregate time required to make one unit of product.” Do you agree? What allowances should be made in setting this standard?

8. How is the predetermined overhead rate determined when standard costs are used?

9. What is the difference between a favorable cost variance and an unfavorable cost variance?

10. In each of the following formulas, supply the words that should be inserted for each number in parentheses.

(a) (Actual quantity×(1))−(Standard quantity×(2))=Total materials variance(Actual quantity×(1))−(Standard quantity×(2))=Total materials variance

(b) ((3)×Actual price)−(Actual quantity×(4))=Materials price variance((3)×Actual price)−(Actual quantity×(4))=Materials price variance

(c) (Actual quantity×(5))−((6)×Standard price)=Materials quantity variance(Actual quantity×(5))−((6)×Standard price)=Materials quantity variance

11. In the direct labor variance matrix, there are three factors: (1) Actual hours×Actual rateActual hours×Actual rate, (2) Actual hours×Standard rateActual hours×Standard rate, and (3) Standard hours×Standard rateStandard hours×Standard rate. Using the numbers, indicate the formulas for each of the direct labor variances.

12. Mikan Company's standard predetermined overhead rate is $9 per direct labor hour. For the month of June, 26,000 actual hours were worked, and 27,000 standard hours were allowed. How much overhead was applied?

13. How often should variances be reported to management? What principle may be used with variance reports?

14. What circumstances may cause the purchasing department to be responsible for both an unfavorable materials price variance and an unfavorable materials quantity variance?

15. What are the four perspectives used in the balanced scorecard? Discuss the nature of each, and how the perspectives are linked.

16. Kerry James says that the balanced scorecard was created to replace financial measures as the primary mechanism for performance evaluation. He says that it uses only nonfinancial measures. Is this true?

17. What are some examples of nonfinancial measures used by companies to evaluate performance?

18. (a) How are variances reported in income statements prepared for management? (b) May standard costs be used in preparing financial statements for stockholders? Explain.

*19. (a) Explain the basic features of a standard cost accounting system. (b) What type of balance will exist in the variance account when (1) the materials price variance is unfavorable and (2) the labor quantity variance is favorable?

*20. If the $9 per hour overhead rate in Question 12 includes $5 variable, and actual overhead costs were $248,000, what is the overhead controllable variance for June? The normal capacity hours were 28,000. Is the variance favorable or unfavorable?

*21. What is the purpose of computing the overhead volume variance? What is the basic formula for this variance?

*22. Alma Ortiz does not understand why the overhead volume variance indicates that fixed overhead costs are under‐ or overapplied. Clarify this matter for Alma.

*23. John Hsu is attempting to outline the important points about overhead variances on a class examination. List four points that John should include in his outline.

BRIEF EXERCISES

Distinguish between a standard and a budget.

(LO 1), AP

BE23-1 Lopez Company uses both standards and budgets. For the year, estimated production of Product X is 500,000 units. Total estimated cost for materials and labor are $1,400,000 and $1,700,000. Compute the estimates for (a) a standard cost and (b) a budgeted cost.

Set direct materials standard.

(LO 1), AP

BE23-2 Tang Company accumulates the following data concerning raw materials in making one gallon of finished product. (1) Price—net purchase price $2.30, freight‐in $0.20, and receiving and handling $0.10. (2) Quantity—required materials 3.6 pounds, allowance for waste and spoilage 0.4 pounds. Compute the following.

(a) Standard direct materials price per gallon.

(b) Standard direct materials quantity per gallon.

Set direct labor standard.

(LO 1), AP

BE23-3 Labor data for making one gallon of finished product in Bing Company are as follows. (1) Price—hourly wage rate $14.00, payroll taxes $0.80, and fringe benefits $1.20. (2) Quantity—actual production time 1.1 hours, rest periods and cleanup 0.25 hours, and setup and downtime 0.15 hours. Compute the following.

(a) Standard direct labor rate per hour.

(b) Standard direct labor hours per gallon.

Compute direct materials variances.

(LO 2), AP

BE23-4 Simba Company's standard materials cost per unit of output is $10 (2 pounds×$5)$10 (2 pounds×$5). During July, the company purchases and uses 3,200 pounds of materials costing $16,192 in making 1,500 units of finished product. Compute the total, price, and quantity materials variances.

Compute direct labor variances.

(LO 3), AP

BE23-5 Mordica Company's standard labor cost per unit of output is $22 (2 hours×$11 per hour)$22 (2 hours×$11 per hour). During August, the company incurs 2,150 hours of direct labor at an hourly cost of $10.80 per hour in making 1,000 units of finished product. Compute the total, price, and quantity labor variances.

Compute total overhead variance.

(LO 3), AP

BE23-6 In October, Pine Company reports 21,000 actual direct labor hours, and it incurs $118,000 of manufacturing overhead costs. Standard hours allowed for the work done is 20,600 hours. The predetermined overhead rate is $6 per direct labor hour. Compute the total overhead variance.

Match balanced scorecard perspectives.

(LO 4), AP

BE23-7 The four perspectives in the balanced scorecard are (1) financial, (2) customer, (3) internal process, and (4) learning and growth. Match each of the following objectives with the perspective it is most likely associated with: (a) plant capacity utilization, (b) employee work days missed due to injury, (c) return on assets, and (d) brand recognition.

Journalize materials variances.

(LO 5), AP

*BE23-8 Journalize the following transactions for Combs Company.

(a) Purchased 6,000 units of raw materials on account for $11,500. The standard cost was $12,000.

(b) Issued 5,600 units of raw materials for production. The standard units were 5,800.

Journalize labor variances.

(LO 5), AP

*BE23-9 Journalize the following transactions for Shelton, Inc.

(a) Incurred direct labor costs of $24,000 for 3,000 hours. The standard labor cost was $24,900.

(b) Assigned 3,000 direct labor hours costing $24,000 to production. Standard hours were 3,150.

Compute the overhead controllable variance.

(LO 6), AP

*BE23-10 Some overhead data for Pine Company are given in BE23-6. In addition, the flexible manufacturing overhead budget shows that budgeted costs are $4 variable per direct labor hour and $50,000 fixed. Compute the overhead controllable variance.

Compute overhead volume variance.

(LO 6), AP

*BE23-11 Using the data in BE23-6 and BE23-10, compute the overhead volume variance. Normal capacity was 25,000 direct labor hours.

DO IT!

EXERCISES

Compute standard cost.

(LO 1), AP

DO IT! 23-1 Larkin Company accumulated the following standard cost data concerning product I‐Tal.

Direct materials per unit: 2 pounds at $5 per pound

Direct labor per unit: 0.2 hours at $16 per hour

Manufacturing overhead: Allocated based on direct labor hours at a predetermined rate of $20 per direct labor hour

Compute the standard cost of one unit of product I‐Tal.

Compute materials variance.

(LO 2), AP

DO IT! 23-2 The standard cost of product 777 includes 2 units of direct materials at $6.00 per unit. During August, the company bought 29,000 units of materials at $6.30 and used those materials to produce 16,000 units. Compute the total, price, and quantity variances for materials.

Compute labor and manufacturing overhead variances.

(LO 3), AP

DO IT! 23-3 The standard cost of product 5252 includes 1.9 hours of direct labor at $14.00 per hour. The predetermined overhead rate is $22.00 per direct labor hour. During July, the company incurred 4,000 hours of direct labor at an average rate of $14.30 per hour and $81,300 of manufacturing overhead costs. It produced 2,000 units.

(a) Compute the total, price, and quantity variances for labor. (b) Compute the total overhead variance.

Prepare variance report.

(LO 4), AP

DO IT! 23-4 Tropic Zone Corporation experienced the following variances: materials price $350 U, materials quantity $1,700 F, labor price $800 F, labor quantity $500 F, and overhead $1,200 U. Sales revenue was $92,100, and cost of goods sold (at standard) was $51,600. Determine the actual gross profit.

EXERCISES

Compute budget and standard.

(LO 1), AP

E23-1 Parsons Company is planning to produce 2,000 units of product in 2017. Each unit requires 3 pounds of materials at $5 per pound and a half‐hour of labor at $16 per hour. The overhead rate is 70% of direct labor.

Instructions

(a) Compute the budgeted amounts for 2017 for direct materials to be used, direct labor, and applied overhead.

(b) Compute the standard cost of one unit of product.

Compute standard materials costs.

(LO 1), AP

E23-2 Hank Itzek manufactures and sells homemade wine, and he wants to develop a standard cost per gallon. The following are required for production of a 50‐gallon batch.

1. 3,000 ounces of grape concentrate at $0.06 per ounce

2. 54 pounds of granulated sugar at $0.30 per pound

3. 60 lemons at $0.60 each

4. 50 yeast tablets at $0.25 each

5. 50 nutrient tablets at $0.20 each

6. 2,600 ounces of water at $0.005 per ounce

Hank estimates that 4% of the grape concentrate is wasted, 10% of the sugar is lost, and 25% of the lemons cannot be used.

Instructions

Compute the standard cost of the ingredients for one gallon of wine. (Carry computations to two decimal places.)

Compute standard cost per unit.

(LO 1), AP

E23-3 Stefani Company has gathered the following information about its product.

1. Direct materials. Each unit of product contains 4.5 pounds of materials. The average waste and spoilage per unit produced under normal conditions is 0.5 pounds. Materials cost $5 per pound, but Stefani always takes the 2% cash discount all of its suppliers offer. Freight costs average $0.25 per pound.

2. Direct labor. Each unit requires 2 hours of labor. Setup, cleanup, and downtime average 0.4 hours per unit. The average hourly pay rate of Stefani's employees is $12. Payroll taxes and fringe benefits are an additional $3 per hour.

3. Manufacturing overhead. Overhead is applied at a rate of $7 per direct labor hour.

Instructions

Compute Stefani's total standard cost per unit.

Compute labor cost and labor quantity variance.

(LO 3), AP

E23-4 Monte Services, Inc. is trying to establish the standard labor cost of a typical oil change. The following data have been collected from time and motion studies conducted over the past month.

Actual time spent on the oil change	1.0 hour
Hourly wage rate	$12
Payroll taxes	10% of wage rate
Setup and downtime	20% of actual labor time
Cleanup and rest periods	30% of actual labor time
Fringe benefits	25% of wage rate

Instructions

(a) Determine the standard direct labor hours per oil change.

(b) Determine the standard direct labor hourly rate.

(d) If an oil change took 1.6 hours at the standard hourly rate, what was the direct labor quantity variance?

Compute materials price and quantity variances.

(LO 2), AP

E23-5 The standard cost of Product B manufactured by Pharrell Company includes three units of direct materials at $5.00 per unit. During June, 29,000 units of direct materials are purchased at a cost of $4.70 per unit, and 29,000 units of direct materials are used to produce 9,400 units of Product B.

Instructions

(a) Compute the total materials variance and the price and quantity variances.

(b) Repeat (a), assuming the purchase price is $5.15 and the quantity purchased and used is 28,000 units.

Compute labor price and quantity variances.

(LO 3), AP

E23-6 Lewis Company's standard labor cost of producing one unit of Product DD is 4 hours at the rate of $12.00 per hour. During August, 40,600 hours of labor are incurred at a cost of $12.15 per hour to produce 10,000 units of Product DD.

Instructions

(a) Compute the total labor variance.

(b) Compute the labor price and quantity variances.

Compute materials and labor variances.

(LO 2, 3), AP

E23-7 Levine Inc., which produces a single product, has prepared the following standard cost sheet for one unit of the product.

Direct materials (8 pounds at $2.50 per pound)	$20
Direct labor (3 hours at $12.00 per hour)	$36

During the month of April, the company manufactures 230 units and incurs the following actual costs.

Direct materials purchased and used (1,900 pounds)	$5,035
Direct labor (700 hours)	$8,120

Instructions

Compute the total, price, and quantity variances for materials and labor.

Compute the materials and labor variances and list reasons for unfavorable variances.

(LO 2, 3), AN

E23-8 The following direct materials and direct labor data pertain to the operations of Laurel Company for the month of August.

Costs	QUANTITIES
Actual labor rate	$13 per hour	Actual hours incurred and used	4,150 hours
Actual materials price	$128 per ton	Actual quantity of materials purchased and used	1,220 tons
Standard labor rate	$12.50 per hour	Standard hours used	4,300 hours
Standard materials price	$130 per ton	Standard quantity of materials used	1,200 tons

Instructions

(a) Compute the total, price, and quantity variances for materials and labor.

(b) Provide two possible explanations for each of the unfavorable variances calculated above, and suggest where responsibility for the unfavorable result might be placed.

Determine amounts from variance report.

(LO 2, 3), AN

E23-9 You have been given the following information about the production of Usher Co., and are asked to provide the plant manager with information for a meeting with the vice president of operations.

	Standard Cost Card
Direct materials (5 pounds at $4 per pound)	$20.00
Direct labor (0.8 hours at $10)	8.00
Variable overhead (0.8 hours at $3 per hour)	2.40
Fixed overhead (0.8 hours at $7 per hour)	5.60
	$36.00

The following is a variance report for the most recent period of operations.

		Variances
Costs	Total Standard Cost	Price	Quantity
Direct materials	$410,000	$2,095 F	$9,000 U
Direct labor	164,000	3,840 U	6,000 U

Instructions

(a) How many units were produced during the period?

(b) How many pounds of raw materials were purchased and used during the period?

(d) How many actual direct labor hours were worked during the period?

(e) What was the actual rate paid per direct labor hour?

(CGA adapted)

Prepare a variance report for direct labor.

(LO 3, 4), AP

E23-10 During March 2017, Toby Tool & Die Company worked on four jobs. A review of direct labor costs reveals the following summary data.

	Actual	Standard	Total
Job Number	Hours	Costs	Hours	Costs	Variance
A257	221	$4,420	225	$4,500	$ 80	F
A258	450	9,450	430	8,600	850	U
A259	300	6,180	300	6,000	180	U
A260	116	2,088	110	2,200	112	F
Total variance					$838	U

Analysis reveals that Job A257 was a repeat job. Job A258 was a rush order that required overtime work at premium rates of pay. Job A259 required a more experienced replacement worker on one shift. Work on Job A260 was done for one day by a new trainee when a regular worker was absent.

Instructions

Prepare a report for the plant supervisor on direct labor cost variances for March. The report should have columns for (1) Job No., (2) Actual Hours, (3) Standard Hours, (4) Quantity Variance, (5) Actual Rate, (6) Standard Rate, (7) Price Variance, and (8) Explanation.

Compute overhead variance.

(LO 3), AN

E23-11 Manufacturing overhead data for the production of Product H by Shakira Company are as follows.

Overhead incurred for 52,000 actual direct labor hours worked	$263,000
Overhead rate (variable $3; fixed $2) at normal capacity of 54,000 direct labor hours	$5
Standard hours allowed for work done	52,000

Instructions

Compute the total overhead variance.

Compute overhead variances.

(LO 3), AP

E23-12 Byrd Company produces one product, a putter called GO‐Putter. Byrd uses a standard cost system and determines that it should take one hour of direct labor to produce one GO‐Putter. The normal production capacity for this putter is 100,000 units per year. The total budgeted overhead at normal capacity is $850,000 comprised of $250,000 of variable costs and $600,000 of fixed costs. Byrd applies overhead on the basis of direct labor hours.

During the current year, Byrd produced 95,000 putters, worked 94,000 direct labor hours, and incurred variable overhead costs of $256,000 and fixed overhead costs of $600,000.

Instructions

(a) Compute the predetermined variable overhead rate and the predetermined fixed overhead rate.

(b) Compute the applied overhead for Byrd for the year.

Compute variances for materials.

(LO 2, 3), AP

E23-13 Ceelo Company purchased (at a cost of $10,200) and used 2,400 pounds of materials during May. Ceelo's standard cost of materials per unit produced is based on 2 pounds per unit at a cost $5 per pound. Production in May was 1,050 units.

Instructions

(a) Compute the total, price, and quantity variances for materials.

(b) Assume Ceelo also had an unfavorable labor quantity variance. What is a possible scenario that would provide one cause for the variances computed in (a) and the unfavorable labor quantity variance?

Prepare a variance report.

(LO 2, 4), AP

E23-14 Picard Landscaping plants grass seed as the basic landscaping for business campuses. During a recent month, the company worked on three projects (Remington, Chang, and Wyco). The company is interested in controlling the materials costs, namely the grass seed, for these plantings projects.

In order to provide management with useful cost control information, the company uses standard costs and prepares monthly variance reports. Analysis reveals that the purchasing agent mistakenly purchased poor‐quality seed for the Remington project. The Chang project, however, received higher‐than‐standard‐quality seed that was on sale. The Wyco project received standard‐quality seed. However, the price had increased and a new employee was used to spread the seed.

Shown below are quantity and cost data for each project.

	Actual	Standard
Project	Quantity	Costs	Quantity	Costs	Total Variance
Remington	500 lbs.	$1,200	460 lbs.	$1,150	$ 50	U
Chang	400	920	410	1,025	105	F
Wyco	550	1,430	480	1,200	230	U
Total variance					$175	U

Instructions

(a) Prepare a variance report for the purchasing department with the following columns: (1) Project, (2) Actual Pounds Purchased, (3) Actual Price per Pound, (4) Standard Price per Pound, (5) Price Variance, and (6) Explanation.

(b) Prepare a variance report for the production department with the following columns: (1) Project, (2) Actual Pounds, (3) Standard Pounds, (4) Standard Price per Pound, (5) Quantity Variance, and (6) Explanation.

Complete variance report.

(LO 4), AP

E23-15 Urban Corporation prepared the following variance report.

URBAN CORPORATION Variance Report—Purchasing Department For the Week Ended January 9, 2017
Type of Materials	Quantity Purchased	Actual Price	Standard Price	Price Variance	Explanation
Rogue11	? lbs.	$5.20	$5.00	$5,500 ?	Price increase
Storm17	7,000 oz.	?	3.30	1,050 U	Rush order
Beast29	22,000 units	0.40	?	660 F	Bought larger quantity

Instructions

Fill in the appropriate amounts or letters for the question marks in the report.

Prepare income statement for management.

(LO 4), AP

E23-16 Fisk Company uses a standard cost accounting system. During January, the company reported the following manufacturing variances.

Materials price variance	$1,200 U	Labor quantity variance	$750 U
Materials quantity variance	800 F	Overhead variance	800 U
Labor price variance	550 U

In addition, 8,000 units of product were sold at $8 per unit. Each unit sold had a standard cost of $5. Selling and administrative expenses were $8,000 for the month.

Instructions

Prepare an income statement for management for the month ended January 31, 2017.

Identify performance evaluation terminology.

(LO 1, 4), C

E23-17 The following is a list of terms related to performance evaluation.

1. Balanced scorecard

2. Variance

3. Learning and growth perspective

4. Nonfinancial measures

5. Customer perspective

6. Internal process perspective

7. Ideal standards

8. Normal standards

Instructions

Match each of the following descriptions with one of the terms above.

(a) The difference between total actual costs and total standard costs.

(b) An efficient level of performance that is attainable under expected operating conditions.

(c) An approach that incorporates financial and nonfinancial measures in an integrated system that links performance measurement and a company's strategic goals.

(d) A viewpoint employed in the balanced scorecard to evaluate how well a company develops and retains its employees.

(e) An evaluation tool that is not based on dollars.

(f) A viewpoint employed in the balanced scorecard to evaluate the company from the perspective of those people who buy its products or services.

(g) An optimum level of performance under perfect operating conditions.

(h) A viewpoint employed in the balanced scorecard to evaluate the efficiency and effectiveness of the company's value chain.

Identity balanced scorecard perspectives.

(LO 4), C

E23-18 Indicate which of the four perspectives in the balanced scorecard is most likely associated with the objectives that follow.

1. Percentage of repeat customers.

2. Number of suggestions for improvement from employees.

3. Contribution margin.

4. Brand recognition.

5. Number of cross‐trained employees.

6. Amount of setup time.

Identify balance scorecard perspectives.

(LO 4), C

E23-19 Indicate which of the four perspectives in the balanced scorecard is most likely associated with the objectives that follow.

1. Ethics violations.

2. Credit rating.

3. Customer retention.

4. Stockouts.

5. Reportable accidents.

6. Brand recognition.

Journalize entries in a standard cost accounting system.

(LO 5), AP

E23-20 Vista Company installed a standard cost system on January 1. Selected transactions for the month of January are as follows.

1. Purchased 18,000 units of raw materials on account at a cost of $4.50 per unit. Standard cost was $4.40 per unit.

2. Issued 18,000 units of raw materials for jobs that required 17,500 standard units of raw materials.

3. Incurred 15,300 actual hours of direct labor at an actual rate of $5.00 per hour. The standard rate is $5.50 per hour. (Credit Factory Wages Payable.)

4. Performed 15,300 hours of direct labor on jobs when standard hours were 15,400.

5. Applied overhead to jobs at the rate of 100% of direct labor cost for standard hours allowed.

Instructions

Journalize the January transactions.

Answer questions concerning missing entries and balances.

(LO 2, 3, 5), AN

*E23-21 Lopez Company uses a standard cost accounting system. Some of the ledger accounts have been destroyed in a fire. The controller asks your help in reconstructing some missing entries and balances.

Instructions

Answer the following questions.

(a) Materials Price Variance shows a $2,000 unfavorable balance. Accounts Payable shows $138,000 of raw materials purchases. What was the amount debited to Raw Materials Inventory for raw materials purchased?

(b) Materials Quantity Variance shows a $3,000 favorable balance. Raw Materials Inventory shows a zero balance. What was the amount debited to Work in Process Inventory for direct materials used?

(c) Labor Price Variance shows a $1,500 favorable balance. Factory Labor shows a debit of $145,000 for wages incurred. What was the amount credited to Factory Wages Payable?

(d) Factory Labor shows a credit of $145,000 for direct labor used. Labor Quantity Variance shows a $900 favorable balance. What was the amount debited to Work in Process for direct labor used?

(e) Overhead applied to Work in Process totaled $165,000. If the total overhead variance was $1,200 favorable, what was the amount of overhead costs debited to Manufacturing Overhead?

Journalize entries for materials and labor variances.

(LO 5), AP

*E23-22 Data for Levine Inc. are given in E23-7.

Instructions

Journalize the entries to record the materials and labor variances.

Compute manufacturing overhead variances and interpret findings.

(LO 6), AN

*E23-23 The information shown below was taken from the annual manufacturing overhead cost budget of Connick Company.

Variable manufacturing overhead costs	$34,650
Fixed manufacturing overhead costs	$19,800
Normal production level in labor hours	16,500
Normal production level in units	4,125
Standard labor hours per unit	4

During the year, 4,050 units were produced, 16,100 hours were worked, and the actual manufacturing overhead was $55,500. Actual fixed manufacturing overhead costs equaled budgeted fixed manufacturing overhead costs. Overhead is applied on the basis of direct labor hours.

Instructions

(a) Compute the total, fixed, and variable predetermined manufacturing overhead rates.

(b) Compute the total, controllable, and volume overhead variances.

Compute overhead variances.

(LO 6), AN

*E23-24 The loan department of Calgary Bank uses standard costs to determine the overhead cost of processing loan applications. During the current month, a fire occurred, and the accounting records for the department were mostly destroyed. The following data were salvaged from the ashes.

Standard variable overhead rate per hour	$9
Standard hours per application	2
Standard hours allowed	2,000
Standard fixed overhead rate per hour	$6
Actual fixed overhead cost	$12,600
Variable overhead budget based on standard hours allowed	$18,000
Fixed overhead budget	$12,600
Overhead controllable variance	$ 1,200	U

Instructions

(a) Determine the following.

(1) Total actual overhead cost.

(2) Actual variable overhead cost.

(3) Variable overhead costs applied.

(4) Fixed overhead costs applied.

(5) Overhead volume variance.

(b) Determine how many loans were processed.

Compute variances.

(LO 6), AP

*E23-25 Seacrest Company's overhead rate was based on estimates of $200,000 for overhead costs and 20,000 direct labor hours. Seacrest's standards allow 2 hours of direct labor per unit produced. Production in May was 900 units, and actual overhead incurred in May was $19,500. The overhead budgeted for 1,800 standard direct labor hours is $17,600 ($5,000 fixed and $12,600 variable).

Instructions

(a) Compute the total, controllable, and volume variances for overhead.

(b) What are possible causes of the variances computed in part (a)?

EXERCISES: SET B AND CHALLENGE EXERCISES

Visit the book's companion website, at www.wiley.com/college/kimmel , and choose the Student Companion site to access Exercises: Set B and Challenge Exercises.

PROBLEMS: SET A

Compute variances.

(LO 2, 3), AP

P23-1A Rogen Corporation manufactures a single product. The standard cost per unit of product is shown below.

Direct materials—1 pound plastic at $7.00 per pound	$ 7.00
Direct labor—1.6 hours at $12.00 per hour	19.20
Variable manufacturing overhead	12.00
Fixed manufacturing overhead	4.00
Total standard cost per unit	$42.20

The predetermined manufacturing overhead rate is $10 per direct labor hour ($16.00÷1.6)($16.00÷1.6). It was computed from a master manufacturing overhead budget based on normal production of 8,000 direct labor hours (5,000 units) for the month. The master budget showed total variable costs of $60,000 ($7.50 per hour) and total fixed overhead costs of $20,000 ($2.50 per hour). Actual costs for October in producing 4,800 units were as follows.

Direct materials (5,100 pounds)	$ 36,720
Direct labor (7,400 hours)	92,500
Variable overhead	59,700
Fixed overhead	21,000
Total manufacturing costs	$209,920

The purchasing department buys the quantities of raw materials that are expected to be used in production each month. Raw materials inventories, therefore, can be ignored.

Instructions

(a) Compute all of the materials and labor variances.

(a) MPV $1,020 U

(b) Compute the total overhead variance.

Compute variances, and prepare income statement.

(LO 2, 3, 4), AP

P23-2A Ayala Corporation accumulates the following data relative to jobs started and finished during the month of June 2017.

Costs and Production Data	Actual	Standard
Raw materials unit cost	$2.25	$2.10
Raw materials units used	10,600	10,000
Direct labor payroll	$120,960	$120,000
Direct labor hours worked	14,400	15,000
Manufacturing overhead incurred	$189,500
Manufacturing overhead applied		$193,500
Machine hours expected to be used at normal capacity		42,500
Budgeted fixed overhead for June		$55,250
Variable overhead rate per machine hour		$3.00
Fixed overhead rate per machine hour		$1.30

Overhead is applied on the basis of standard machine hours. Three hours of machine time are required for each direct labor hour. The jobs were sold for $400,000. Selling and administrative expenses were $40,000. Assume that the amount of raw materials purchased equaled the amount used.

Instructions

(a) Compute all of the variances for (1) direct materials and (2) direct labor.

(a) LQV $4,800 F

(b) Compute the total overhead variance.

Compute and identify significant variances.

(LO 2, 3, 4), AN

P23-3A Rudd Clothiers is a small company that manufactures tall‐men's suits. The company has used a standard cost accounting system. In May 2017, 11,250 suits were produced. The following standard and actual cost data applied to the month of May when normal capacity was 14,000 direct labor hours. All materials purchased were used.

Cost Element	Standard (per unit)	Actual
Direct materials	8 yards at $4.40 per yard	$375,575 for 90,500 yards
		($4.15 per yard)
Direct labor	1.2 hours at $13.40 per hour	$200,925 for 14,250 hours
		($14.10 per hour)
Overhead	1.2 hours at $6.10 per hour	$49,000 fixed overhead
	(fixed $3.50; variable $2.60)	$37,000 variable overhead

Overhead is applied on the basis of direct labor hours. At normal capacity, budgeted fixed overhead costs were $49,000, and budgeted variable overhead was $36,400.

Instructions

(a) Compute the total, price, and quantity variances for (1) materials and (2) labor.

(a) MPV $22,625 F

(b) Compute the total overhead variance.

(c) Which of the materials and labor variances should be investigated if management considers a variance of more than 4% from standard to be significant?

Answer questions about variances.

(LO 2, 3), AN

P23-4A Kansas Company uses a standard cost accounting system. In 2017, the company produced 28,000 units. Each unit took several pounds of direct materials and 1.6 standard hours of direct labor at a standard hourly rate of $12.00. Normal capacity was 50,000 direct labor hours. During the year, 117,000 pounds of raw materials were purchased at $0.92 per pound. All materials purchased were used during the year.

Instructions

(a) If the materials price variance was $3,510 favorable, what was the standard materials price per pound?

(b) If the materials quantity variance was $4,750 unfavorable, what was the standard materials quantity per unit?

(b) 4.0 pounds

(d) If the labor quantity variance was $7,200 unfavorable, what were the actual direct labor hours worked?

(e) If the labor price variance was $9,080 favorable, what was the actual rate per hour?

(f) If total budgeted manufacturing overhead was $360,000 at normal capacity, what was the predetermined overhead rate?

(f) $7.20 per DLH

(g) What was the standard cost per unit of product?

(h) How much overhead was applied to production during the year?

(i) Using one or more answers above, what were the total costs assigned to work in process?

Compute variances, prepare an income statement, and explain unfavorable variances.

(LO 2, 3, 4), AP

P23-5A Hart Labs, Inc. provides mad cow disease testing for both state and federal governmental agricultural agencies. Because the company's customers are governmental agencies, prices are strictly regulated. Therefore, Hart Labs must constantly monitor and control its testing costs. Shown below are the standard costs for a typical test.

Direct materials (2 test tubes @ $1.46 per tube)	$ 2.92
Direct labor (1 hour @ $24 per hour)	24.00
Variable overhead (1 hour @ $6 per hour)	6.00
Fixed overhead (1 hour @ $10 per hour)	10.00
Total standard cost per test	$42.92

The lab does not maintain an inventory of test tubes. As a result, the tubes purchased each month are used that month. Actual activity for the month of November 2017, when 1,475 tests were conducted, resulted in the following.

Direct materials (3,050 test tubes)	$ 4,270
Direct labor (1,550 hours)	35,650
Variable overhead	7,400
Fixed overhead	15,000

Monthly budgeted fixed overhead is $14,000. Revenues for the month were $75,000, and selling and administrative expenses were $5,000.

Instructions

(a) Compute the price and quantity variances for direct materials and direct labor.

(a) LQV $1,800 U

(b) Compute the total overhead variance.

(d) Provide possible explanations for each unfavorable variance.

Journalize and post standard cost entries, and prepare income statement.

(LO 2, 3, 4, 5), AP

*P23-6A Jorgensen Corporation uses standard costs with its job order cost accounting system. In January, an order (Job No. 12) for 1,900 units of Product B was received. The standard cost of one unit of Product B is as follows.

Direct materials	3 pounds at $1.00 per pound	$ 3.00
Direct labor	1 hour at $8.00 per hour	8.00
Overhead	2 hours (variable $4.00 per machine hour; fixed $2.25 per machine hour)	12.50
Standard cost per unit		$23.50

Normal capacity for the month was 4,200 machine hours. During January, the following transactions applicable to Job No. 12 occurred.

1. Purchased 6,200 pounds of raw materials on account at $1.05 per pound.

2. Requisitioned 6,200 pounds of raw materials for Job No. 12.

3. Incurred 2,000 hours of direct labor at a rate of $7.80 per hour.

4. Worked 2,000 hours of direct labor on Job No. 12.

5. Incurred manufacturing overhead on account $25,000.

6. Applied overhead to Job No. 12 on basis of standard machine hours allowed.

7. Completed Job No. 12.

8. Billed customer for Job No. 12 at a selling price of $65,000.

Instructions

(a) Journalize the transactions.

(b) Post to the job order cost accounts.

(d) Prepare the January 2017 income statement for management. Assume selling and administrative expenses were $2,000.

(d) NI $15,890

Compute overhead controllable and volume variances.

(LO 6), AP

*P23-7A Using the information in P23-1A , compute the overhead controllable variance and the overhead volume variance.

Compute overhead controllable and volume variances.

(LO 6), AP

*P23-8A Using the information in P23-2A , compute the overhead controllable variance and the overhead volume variance.

Compute overhead controllable and volume variances.

(LO 6), AP

*P23-9A Using the information in P23-3A , compute the overhead controllable variance and the overhead volume variance.

Compute overhead controllable and volume variances.

(LO 6), AP

*P23-10A Using the information in P23-5A , compute the overhead controllable variance and the overhead volume variance.

PROBLEMS: SET B AND SET C

Visit the book's companion website, at www.wiley.com/college/kimmel , and choose the Student Companion site to access Problems: Set B and Set C.

CONTINUING PROBLEMS

CURRENT DESIGNS

CD23 The executive team at Current Designs has gathered to evaluate the company's operations for the last month. One of the topics on the agenda is the special order from Huegel Hollow, which was presented in CD2. Recall that Current Designs had a special order to produce a batch of 20 kayaks for a client, and you were asked to determine the cost of the order and the cost per kayak.

EXCEL TUTORIAL

Mike Cichanowski asked the others if the special order caused any particular problems in the production process. Dave Thill, the production manager, made the following comments: “Since we wanted to complete this order quickly and make a good first impression on this new customer, we had some of our most experienced type I workers run the rotomold oven and do the trimming. They were very efficient and were able to complete that part of the manufacturing process even more quickly than the regular crew. However, the finishing on these kayaks required a different technique than what we usually use, so our type II workers took a little longer than usual for that part of the process.”

Deb Welch, who is in charge of the purchasing function, said, “We had to pay a little more for the polyethylene powder for this order because the customer wanted a color that we don't usually stock. We also ordered a little extra since we wanted to make sure that we had enough to allow us to calibrate the equipment. The calibration was a little tricky, and we used all of the powder that we had purchased. Since the number of kayaks in the order was fairly small, we were able to use some rope and other parts that were left over from last year's production in the finishing kits. We've seen a price increase for these components in the last year, so using the parts that we already had in inventory cut our costs for the finishing kits.”

Instructions

(a) Based on the comments above, predict whether each of the following variances will be favorable or unfavorable. If you don't have enough information to make a prediction, use “NEI” to indicate “Not Enough Information.”

1. Quantity variance for polyethylene powder.

2. Price variance for polyethylene powder.

3. Quantity variance for finishing kits.

4. Price variance for finishing kits.

5. Quantity variance for type I workers.

6. Price variance for type I workers.

7. Quantity variance for type II workers.

8. Price variance for type II workers.

(b) Diane Buswell examined some of the accounting records and reported that Current Designs purchased 1,200 pounds of pellets for this order at a total cost of $2,040. Twenty (20) finishing kits were assembled at a total cost of $3,240. The payroll records showed that the type I employees worked 38 hours on this project at a total cost of $570. The type II finishing employees worked 65 hours at a total cost of $796.25. A total of 20 kayaks were produced for this order.

The standards that had been developed for this model of kayak were used in CD2 and are reproduced here. For each kayak:

1. 54 pounds of polyethylene powder at $1.50 per pound

2. 1 finishing kit (rope, seat, hardware, etc.) at $170

3. 2 hours of type I labor from people who run the oven and trim the plastic at a standard wage rate of $15 per hour

4. 3 hours of type II labor from people who attach the hatches and seat and other hardware at a standard wage rate of $12 per hour.

Calculate the eight variances that are listed in part (a) of this problem.

WATERWAYS

(This is a continuation of the Waterways problem from Chapters 14 – 22 .)

WP23 Waterways Corporation uses very stringent standard costs in evaluating its manufacturing efficiency. These standards are not “ideal” at this point, but management is working toward that as a goal. This problem asks you to calculate and evaluate the company's variances.

Go to the book's companion website, at www.wiley.com/college/kimmel , to find the completion of this problem.

EXPAND YOUR | CRITICAL THINKING

DECISION‐MAKING ACROSS THE ORGANIZATION

CT23-1 Milton Professionals, a management consulting firm, specializes in strategic planning for financial institutions. James Hahn and Sara Norton, partners in the firm, are assembling a new strategic planning model for use by clients. The model is designed for use on most personal computers and replaces a rather lengthy manual model currently marketed by the firm. To market the new model, James and Sara will need to provide clients with an estimate of the number of labor hours and computer time needed to operate the model. The model is currently being test‐marketed at five small financial institutions. These financial institutions are listed below, along with the number of combined computer/labor hours used by each institution to run the model one time.

Financial Institutions	Computer/Labor Hours Required
Midland National	25
First State	45
Financial Federal	40
Pacific America	30
Lakeview National	30
Total	170
Average	34

Any company that purchases the new model will need to purchase user manuals for the system. User manuals will be sold to clients in cases of 20, at a cost of $320 per case. One manual must be used each time the model is run because each manual includes a nonreusable computer‐accessed password for operating the system. Also required are specialized computer forms that are sold only by Milton. The specialized forms are sold in packages of 250, at a cost of $60 per package. One application of the model requires the use of 50 forms. This amount includes two forms that are generally wasted in each application due to printer alignment errors. The overall cost of the strategic planning model to clients is $12,000. Most clients will use the model four times annually.

Milton must provide its clients with estimates of ongoing costs incurred in operating the new planning model, and would like to do so in the form of standard costs.

Instructions

With the class divided into groups, answer the following.

(a) What factors should be considered in setting a standard for computer/labor hours?

(b) What alternatives for setting a standard for computer/labor hours might be used?

(d) Determine the standard materials cost associated with the user manuals and computer forms for each application of the strategic planning model.

MANAGERIAL ANALYSIS

*CT23-2 Ana Carillo and Associates is a medium‐sized company located near a large metropolitan area in the Midwest. The company manufactures cabinets of mahogany, oak, and other fine woods for use in expensive homes, restaurants, and hotels. Although some of the work is custom, many of the cabinets are a standard size.

One such non‐custom model is called Luxury Base Frame. Normal production is 1,000 units. Each unit has a direct labor hour standard of 5 hours. Overhead is applied to production based on standard direct labor hours. During the most recent month, only 900 units were produced; 4,500 direct labor hours were allowed for standard production, but only 4,000 hours were used. Standard and actual overhead costs were as follows.

	Standard (1,000 units)	Actual (900 units)
Indirect materials	$ 12,000	$ 12,300
Indirect labor	43,000	51,000
(Fixed) Manufacturing supervisors salaries	22,500	22,000
(Fixed) Manufacturing office employees salaries	13,000	12,500
(Fixed) Engineering costs	27,000	25,000
Computer costs	10,000	10,000
Electricity	2,500	2,500
(Fixed) Manufacturing building depreciation	8,000	8,000
(Fixed) Machinery depreciation	3,000	3,000
(Fixed) Trucks and forklift depreciation	1,500	1,500
Small tools	700	1,400
(Fixed) Insurance	500	500
(Fixed) Property taxes	300	300
Total	$144,000	$150,000

Instructions

(a) Determine the overhead application rate.

(b) Determine how much overhead was applied to production.

(d) Decide which overhead variances should be investigated.

(e) Discuss causes of the overhead variances. What can management do to improve its performance next month?

REAL‐WORLD FOCUS

CT23-3 Glassmaster Company is organized as two divisions and one subsidiary. One division focuses on the manufacture of filaments such as fishing line and sewing thread; the other division manufactures antennas and specialty fiberglass products. Its subsidiary manufactures flexible steel wire controls and molded control panels.

The annual report of Glassmaster provides the following information.

GLASSMASTER COMPANY Management Discussion

Gross profit margins for the year improved to 20.9% of sales compared to last year's 18.5%. All operations reported improved margins due in large part to improved operating efficiencies as a result of cost reduction measures implemented during the second and third quarters of the fiscal year and increased manufacturing throughout due to higher unit volume sales. Contributing to the improved margins was a favorable materials price variance due to competitive pricing by suppliers as a result of soft demand for petrochemical‐based products. This favorable variance is temporary and will begin to reverse itself as stronger worldwide demand for commodity products improves in tandem with the economy. Partially offsetting these positive effects on profit margins were competitive pressures on sales prices of certain product lines. The company responded with pricing strategies designed to maintain and/or increase market share.

Instructions

(a) Is it apparent from the information whether Glassmaster utilizes standard costs?

(b) Do you think the price variance experienced should lead to changes in standard costs for the next fiscal year?

C CT23-4 The Balanced Scorecard Institute (www.balancedscorecard.org) is a great resource for information about implementing the balanced scorecard. One item of interest provided at its website is an example of a balanced scorecard for a regional airline.

Address: http://www.balancedscorecard.org/portals/0/pdf/regional_airline.pdf, or go to www.wiley.com/college/kimmel

Instructions

Go to the address above and answer the following questions.

(a) What are the objectives identified for the airline for each perspective?

(b) What measures are used for the objectives in the customer perspective?

AN CT23-5 The December 22, 2009, edition of the Wall Street Journal has an article by Kevin Kelliker entitled “In Risky Move, GM to Run Plants Around Clock.”

Instructions

Read the article and answer the following questions.

(a) According to the article, what is the normal industry standard for plants to be considered operating at full capacity?

(b) What ideal standard is the company hoping to achieve?

(c) What reasons are given in the article for why most companies do not operate a third shift? How does GM propose to overcome these issues?

(d) What are some potential drawbacks of the midnight shift? What implications does this have for variances from standards?

(e) What potential sales/marketing disadvantage does the third shift create?

COMMUNICATION ACTIVITY

CT23-6 The setting of standards is critical to the effective use of standards in evaluating performance.

Instructions

Explain the following in a memo to your instructor.

(a) The comparative advantages and disadvantages of ideal versus normal standards.

(b) The factors that should be included in setting the price and quantity standards for direct materials, direct labor, and manufacturing overhead.

ETHICS CASE

CT23-7 At Symond Company, production workers in the Painting Department are paid on the basis of productivity. The labor time standard for a unit of production is established through periodic time studies conducted by Douglas Management Consultants. In a time study, the actual time required to complete a specific task by a worker is observed. Allowances are then made for preparation time, rest periods, and cleanup time. Bill Carson is one of several veterans in the Painting Department.

Bill is informed by Douglas that he will be used in the time study for the painting of a new product. The findings will be the basis for establishing the labor time standard for the next 6 months. During the test, Bill deliberately slows his normal work pace in an effort to obtain a labor time standard that will be easy to meet. Because it is a new product, the Douglas representative who conducted the test is unaware that Bill did not give the test his best effort.

Instructions

(a) Who was benefited and who was harmed by Bill's actions?

(b) Was Bill ethical in the way he performed the time study test?

ALL ABOUT YOU

CT23-8 From the time you first entered school many years ago, instructors have been measuring and evaluating you by imposing standards. In addition, many of you will pursue professions that administer professional examinations to attain recognized certification. A federal commission presented proposals suggesting all public colleges and universities should require standardized tests to measure their students' learning.

Instructions

Read the article at www.signonsandiego.com/uniontrib/20060811/news_1n11colleges.html, and answer the following questions.

(a) What areas of concern did the panel's recommendations address?

(b) What are possible advantages of standard testing?

(d) Would you be in favor of standardized tests?

CONSIDERING YOUR COSTS AND BENEFITS

CT23-9 Do you think that standard costs are used only in making products like wheel bearings and hamburgers? Think again. Standards influence virtually every aspect of our lives. For example, the next time you call to schedule an appointment with your doctor, ask the receptionist how many minutes the appointment is scheduled for. Doctors are under increasing pressure to see more patients each day, which means the time spent with each patient is shorter. As insurance companies and employers push for reduced medical costs, every facet of medicine has been standardized and analyzed. Doctors, nurses, and other medical staff are evaluated in every part of their operations to ensure maximum efficiency. While keeping medical treatment affordable seems like a worthy goal, what are the potential implications for the quality of health care? Does a focus on the bottom line result in a reduction in the quality of health care?

A simmering debate has centered on a very basic question: To what extent should accountants, through financial measures, influence the type of medical care that you receive? Suppose that your local medical facility is in danger of closing because it has been losing money. Should the facility put in place incentives that provide bonuses to doctors if they meet certain standard‐cost targets for the cost of treating specific ailments?

1. YES: If the facility is in danger of closing, then someone should take steps to change the medical practices to reduce costs. A closed medical facility is of no use to me, my family, or the community.

2. NO: I don't want an accountant deciding the right medical treatment for me. My family and I deserve the best medical care.

Instructions

Write a response indicating your position regarding this situation. Provide support for your view.

1 Assume that all materials purchased durin