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Chapter 11Standard Costs and Variance Analysis

LEARNING OBJECTIVES

Chapter 11 addresses the following questions:

Q1 How are standard costs established?Q2 What is variance analysis, and how is it performed?Q3 How are direct cost variances calculated?Q4 How is direct cost variance information analyzed and used?Q5 How are variable and fixed overhead variances calculated?Q6 How is overhead variance information analyzed and used?Q7 How are manufacturing cost variances closed?Q8 Which profit-related variances are commonly analyzed? (Appendix 11A)

These learning questions (Q1 through Q8) are cross-referenced in the textbook to individual exercises and problems.

COMPLEXITY SYMBOLS

The textbook uses a coding system to identify the complexity of individual requirements in the exercises and problems.

Questions Having a Single Correct Answer:No Symbol This question requires students to recall or apply knowledge as shown in the

textbook.e This question requires students to extend knowledge beyond the applications

shown in the textbook.

Open-ended questions are coded according to the skills described in Steps for Better Thinking (Exhibit 1.10):

Step 1 skills (Identifying) Step 2 skills (Exploring) Step 3 skills (Prioritizing) Step 4 skills (Envisioning)

11-2 Cost Management

QUESTIONS

11.1 Managers need information about the costs of direct materials and direct labor as well as whether direct materials and labor have been used efficiently. If the price and efficiency variances are combined, it is impossible to separate the causes of the variance into potential changes in prices of direct materials (or the labor hourly wage) and changes in the amount of materials (or labor hours) used to manufacture the product. Managers need specific information to better monitor operations and investigate changes.

11.2 Utilities are considered fixed costs. These include phone service, natural gas, and electricity. The use of natural gas and electricity is affected by weather patterns. Because weather patterns change, these costs cannot be perfectly predicted. There may be unanticipated price changes in the cost of utilities. In addition, employees could be careless in their use of electricity or telephones. Therefore, variances occur regularly.

11.3 GAAP requires that revenues and expenses be matched. Revenues from the sales of units must be matched to the costs of producing those same units. When a standard cost system is used, production costs are recorded at standard rather than at actual costs. At the end of the accounting period adjusting entries are made to close the variance accounts and to distribute the amounts to inventory and cost of goods sold. These entries simultaneously close the variance accounts and adjust inventory and cost of goods sold to reflect actual costs for the period.

11.4 For a simple but meaningful variance report for costs, the following variances should be calculated.

Price and efficiency variances for direct materials and direct labor provide information about price changes, purchasing efficiencies and the use of materials. Managers can correct some of these problems to insure cost-effective production.

The variable overhead spending variance and the fixed overhead budget variance provide information about whether costs are being kept under control.

The efficiency variance for variable overhead and production volume variances do not provide any incremental information about whether inputs were purchased or used efficiently.

11.5 At the end of the accounting period, the following variances need to be recorded: direct materials and direct labor price and efficiency variances, variable overhead spending variance, fixed overhead budget variance, variable overhead efficiency variance, and production volume variance. If the sum of these is immaterial, it is closed to cost of goods sold. If the sum is material, it is prorated across inventory and COGS.

11.6 Managers monitor variances that are large and unexpected. Sometimes a minimum dollar amount is set as a criteria so that only variances greater than that amount are investigated. Managers make trade-offs between the costs of investigating and the benefit from improving the process or standard. Trends in variances also may affect whether a variance is investigated. If accountants know a variance is increasing over time, they

Chapter 11: Standard Costs and Variance Analysis 11-3

may decide to investigate to identify ways to reverse a negative trend or to modify future standards for a positive trend.

11.7 The cost categories that are measured and monitored in a given organization depend on several factors, including the following:

Nature of goods or services: Manufacturers monitor input prices and efficiency of labor and materials, whereas service organizations monitor cost per service provided, which may not include materials. All organizations monitor fixed costs, although the type of fixed costs varies widely with the type of business.

Cost accounting system used: The cost categories will be more precise with more complex cost accounting systems. An organization with an ABC system that separates costs into flexible and committed categories could develop standards and measure variances for every activity performed. Alternatively, only broad categories may be tracked, such as the traditional direct materials and direct labor categories.

Costs that managers consider important: Overhead costs are often aggregated together and include indirect costs such as oil for machine maintenance. While these costs may not be individually important, they are often monitored as part of the larger category of overhead costs.

Cost/benefit trade-off for monitoring individual costs: For those costs already reported by the accounting system, such as direct labor in a job costing system, the cost to develop standards and monitor variances is probably low, and the benefit could be relatively high if such monitoring encourages labor to be more efficient. However, other costs, indirect materials used during set-ups, may be expensive to track. The benefit from tracking these costs may be low if only very small amounts of materials are used per set-up. These costs are likely to be aggregated into overhead.

11.8 Standard costs are often set using the most recent year’s data. Historical trends may be analyzed and used. Sometimes industrial engineers develop standards by analyzing the manufacturing or service delivery process.

11.9 Recurring favorable variances may indicate that some process has improved. These should be investigated so that standard production practices reflect the process improvements. Variances may also reflect opportunities to examine the manufacturing process and quality of materials to determine improvements. Sometimes the standard is wrong, and the monitoring process is improved by changing the standard to reflect current operations.

11.10 The contribution margin variance calculates the effects of changes in contribution margins, given the actual level of sales. The contribution margin sales volume variance calculates the effects of changes in units sold, given the standard contribution margins. This information helps managers focus on the reason that the contribution margin is


changing. Managers may want to focus on the underlying variable costs, or pricing, or consider product emphasis. These variances help determine whether it’s a change in the volume of sales, or change in the price or variable cost that causes the variance. When sales are slow, prices could be lowered, which would be reflected in the contribution margin variance. These types of changes should be investigated.

11.11 The sales price variance reflects the difference between standard and actual selling prices for the volume of units actually sold. This variance is favorable if the actual selling price exceeds the standard price, and it is unfavorable if the reverse is true. The revenue sales quantity variance reflects the difference between the standard and actual quantity of units sold at the standard selling price. This variance will be favorable when actual quantities exceed standard quantities, and it will be unfavorable otherwise. These variances help managers determine whether changes in revenues are driven by changes in selling price or changes in quantities sold. To remedy any problems, this information is quite useful.

11.12 When the direct materials price variance is large and favorable while direct materials efficiency variance is large and unfavorable, it is possible that lower quality materials are being purchased. This could have a negative effect on the efficiency variance if defective materials are being discarded. Both purchasing and production personnel should be asked whether there has been a change in the quality of materials purchased. Production personnel should also be asked to explain the unfavorable efficiency variances.

11.13 If the direct material price variance is recorded at the time of purchase, direct materials are recorded in inventory at standard cost and do not need to be tracked by purchase date and purchase price. This reduces bookkeeping time and effort and simplifies inventory control. It also clarifies that the price variance occurs at the time of purchase rather than at the time direct materials are used.


EXERCISES

11.14 Kitchen Tile Company

A. This question requires a missing piece of information: the actual number of hours worked. However, because the labor efficiency variance is given, the variance formula can be used to solve for actual labor hours as follows:

Labor efficiency variance = (Standard hours – Actual hours)* Standard price

The variance amount is given as $6,720 Favorable, and the standard labor price is given as $24.00 per hour. The number of standard labor hours is calculated as follows:

Actual production = 18,000 tilesStandard efficiency is 6 tiles per labor hourStandard number of labor hours for 18,000 tiles:

= 18,000 tiles/6 tiles per hour= 3,000 hours

Now solve for actual labor hours using the variance formula:

$6,720 = $24.00 * (3,000 hours – Actual hours)$6,720/$24 = 3,000 – Actual hours280 = 3,000 – Actual hoursActual hours = 3,000 – 280 = 2,720

Quicker approach: The efficiency variance represents the amount by which actual hours exceed standard hours, times the standard price. This means that the efficiency variance represents 280 hours ($6,720/$24). Because the variance was favorable, 280 fewer hours were used than the standard required. For 18,000 tiles, standard labor hours are 3,000 (18,000/6). Therefore, actual hours are 3,000 – 280 = 2,720 hours.

B. The direct labor price variance is calculated using the following formula:

Actual labor hours * (Standard price – Actual price)= 2,720 hours * ($24.00 - $24.50)= $(1,360) Unfavorable

C. The fixed overhead budget (i.e., spending) variance is calculated by simply taking the difference between standard and actual fixed costs:

Standard fixed costs – Actual fixed costs= $60,000 - $58,720= $1,280 Favorable


11.15 Nakatani Enterprises

A. Standard costs for actual output of 15,342 units:Direct materials (15,342 units x 0.8 lbs. x $2.00/lb.) $24,547.20Direct labor (15,342 units x 0.2 hrs x $17.00/hour) 52,162 .80

Total $76,710 .00

B. Direct materials price varianceStandard cost for actual purchases ($2.00/lb x 11,000 lbs.) $22,000Actual cost of purchases 21,730

Price variance $ 270 F

C. Direct materials efficiency varianceStandard quantity of materials for actual output (15,342 x 0.8 lbs.) 12,273.6 lbs.Actual quantity of materials used 13,252 .0 lbs.

Variance in pounds (978.4) lbs.Times standard cost per pound $2

Efficiency variance $(1,956 .80 ) U

D. Direct labor price varianceStandard cost for actual labor hours ($17 x 2,730 hours) $46,410Actual labor cost 47,000

Price variance $ (590) U

E. Direct labor efficiency varianceStandard labor hours for actual output (15,342 x 0.2 hours) 3,068.4Actual labor hours 2,730 .0

Variance in hours 338.4 hoursTimes standard cost per hour $17

Efficiency variance $5,752 .80 F

F. If managers use 10% of total direct costs as the criteria for investigation, none of these variances would be investigated. However, the direct labor efficiency variance is relatively large compared to total direct labor cost at 11% ($5,752.80/$52,162.80). Some managers may want to investigate this variance, especially if this company is concerned about quality as a strategy. If quality has decreased as a result of this favorable variance, defective or low quality units could affect Nakatani’s reputation and future revenues if customers are disgruntled. If production processes have improved, and there is no adverse change in quality, so managers might want to change the labor quantity standard.


11.16 Nell Company

A.Direct material price variance [($0.20 - $0.17) x 100,000] $3,000 FDirect material efficiency variance [(5 * 10,000 - 60,000) x $0.20] 2,000 UDirect labor price variance [($7.00 - $7.20) x 3,900] 780 UDirect labor efficiency variance [(0.4 * 10,000 - 3,900) x $7.00] 700 F

B. Journal entries:Raw materials inventory (100,000 lbs at $0.20/lb.) $20,000

Direct materials price variance $3,000Accounts payable $17,000

Work in process inventory (5*10,000*$0.20) $10,000Direct materials efficiency variance $2,000

Raw materials inventory (60,000 * $0.20) $12,000

Work in process inventory (0.4*10,000*$7.00) $28,000Direct labor price variance $780

Direct labor efficiency variance $700Wages payable (3,900 * $7.20) $28,080

11.17 Derf Company

Standard fixed overhead is $135,000 x 0.20 = $27,000Standard variable overhead is $135,000 x 0.80 = $108,000

The standard fixed overhead allocation rate is $27,000/(9,000 x 2) = $1.50 per hourThe standard variable overhead allocation rate is $108,000/(9,000 x 2) = $6.00 per hour

A. The variable overhead spending variance is:

[$6.00 – ($108,500/17,200)] x 17,200 = $5,300 U

B. The variable overhead efficiency variance is:

[8,500 * 2 - 17,200] x $6 = $1,200 U

C. The fixed overhead spending (budget) variance is:

$27,000 - $28,000 = $1,000 U

D. The fixed production volume variance is:

$1.50 x [(8,500 x 2) – (9,000 x 2)] = $1,500 U


E. Journal entriesVariable overhead cost control (actual cost) $108,500

Accounts payable and other accounts $108,500

Work in Process inventory (8,500 x 2 hrs x $6/hr) 102,000Variable overhead cost control 102,000

Variable overhead spending variance $5,300Variable overhead efficiency variance $1,200

Variable overhead cost control $6,500

Fixed overhead cost control $28,000Accounts payable and other accounts $28,000

WIP inventory (8,500 x 2 x $1.50) $25,500Fixed overhead cost control $25,500

Fixed overhead spending (budget) variance $1,000Production volume variance $1,500

Fixed overhead cost control $2,500

Ending WIP, finished goods, and/or COGSa $9,000Variable overhead spending variance $5,300Variable overhead efficiency variance $1,200Fixed overhead spending (budget) variance $1,000Production volume variance $1,500

a The total variance of $9,000 would be prorated based on the ending balances in work-in-process inventory, finished goods inventory, and cost of goods sold.

11.18 Mitchellville Products Company

A. Revenue budget variance = $60,000 – $53,200 = $6,800 Unfavorable

B. Sales price variance:

Standard unit price = $60,000/4,000 = $15Actual unit price = $14Sales price variance = ($15 - $14) x 3,800 = $3,800. Unfavorable

C. Revenue sales quantity variance = (4,000 – 3,800) x $15 = $3,000 Unfavorable


D. The standard contribution margin is

Sales $60,000Less:

Variable manufacturing 16,000Variable selling and administration 8,000

Contribution margin $36,000

Because contribution margin represents 4,000 units, the contribution margin per unit must be $36,000/4,000 = $9. Then, the contribution margin sales volume variance is

$9 x (4,000 - 3,800) = $1,800 U

11.19 Metropolitan Motors

A. The contribution margin budget variance is the difference between the standard contribution margin and the actual contribution margin.

First, calculate the contribution margin at budget:

Economy (10*$400) $ 4,000Family (20*$800) 16,000Luxury (5*$1,300) 6,500

$ 26,500

The average contribution margin per sale is $26,500/35 = $757.14

The actual contribution margin is

Economy 25 $ 5,625Family 10 7,500Luxury 3 4,200Total 38 $ 17,325

The average contribution margin per sale is $17,325/38 = $455.92

Contribution margin budget variance = $9,175 U because the contribution margin is less than standard.


B. The contribution margin variance reflects the effects of the change in contribution margin, given the actual level of sales.

First calculate what the contribution margin would have been at actual sales and standard contribution margin:

Economy 25 x $400 $10,000Family 10 x $800 8,000Luxury 3 x $1,300 3,900

38 $21,900

The average contribution margin at actual sales mix, standard contribution margin is $21,900/38 = $576.32

Then take the difference between this and the actual contribution margin.

Contribution margin variance = $21,900 - $17,325 = $4,575 U

The contribution margin sales volume variance is the difference between the standard volume, mix, and contribution margin and the actual mix and volume at standard contribution margin or

$21,900 - $26,500 = $4,600 U

Check: The two variances should equal the contribution margin budget variance.

$9,175U = $4,575 U + $4,600 U

C. The contribution margin sales quantity variance is the difference in actual quantity sold and the standard quantity, given the standard sales mix and standard contribution margin. The average contribution margin at standard sales mix and standard contribution margin was calculated above in part A.

(35 - 38) * $757.14 = $2,271.42 F

The contribution margin sales mix variance is the difference between the standard sales mix and the actual sales mix given actual sales at standard contribution margin. This can be calculated two different ways. The actual units and actual sales mix at standard contribution margin total is $21,900. The actual units at standard sales mix and standard contribution margin is $757.14 * 38 = $28,771.32. So the total variance = $21,900 - $28,771 = $6,871.32 U. Alternatively, the averages from above can be used as follows

Contribution margin sales mix variance = ($757.14 - $576.32)*38 = $6,871.16 U

These two variances should sum to the contribution margin sales volume variance of $4,600, and they do ($6,871 - $2,271 = $4,600).


D. No, management would not be pleased. It appears that the bonus induced the salespeople to put more effort into selling the low margin economy cars at the expense of the higher markup lines. Further, the price variance implies that the salespeople also accepted lower prices on the already narrow markups for the economy cars.

11.20 Plush Pet Toys

[Note: This problem requires knowledge of decision making from Chapter 4.]

A. Direct materials variances

Direct material price variance = ($2.00 per yard*30,000 yards) - $62,000 = $60,000 - $62,000 = $2,000 unfavorable because the company paid more than standard

Direct material efficiency standard = 15 yards per lot * 2,400 lots – 34,000 yards)*$2.00 per yard = (36,000 yards – 34,000 yards)*$2.00 per yard = $4,000 favorable because the company used fewer yards than at standard

Direct labor variances:

Direct labor price variance = $10 per hours x 4,200 hours - $39,000) = $42,000 - $39,000 = $3,000 favorable

Direct labor efficiency variance = (2 hrs per lot * 2,400 lots – 4,200 hours)*$10 per hour = (4,800 hours – 4,200 hours)*$10 = $6,000 favorable because the company used fewer hours than at standard

Variable overhead spending variance = ($5 per lot*2,400 lots - $12,000) = $12,000 - $12,000 = $0

There is no spending variance for variable overhead.

Fixed overhead budget variance = $24,000 - $24,920 = $920 unfavorable because the company spent more than standard


The preceding are the commonly used variances for cost control. Some organizations also compute and monitor the following variances:

Variable overhead efficiency variance= [(1,000 lots – 2,400 lots)*$2] = $2,800 unfavorable because the company allocated more overhead than at standard

Production volume varianceGiven that fixed overhead is allocated using the following rate:

$24,000/1,000 = $24/lot= [(1,000 lots – 2,400 lots)*$24/lot]= $33,600 favorable because lots were produced than expected

B.1.

Reduction in labor hours (2.0 hours – 1.5 hours) 0.5 hours per lotTimes cost per hour $10 per hourCost savings per lot $5.00 per lot

2.Cost savings per month = (1,000 lots * $5.00 per lot) = $5,000

Cost savings over 5 years = ($5,000 per month * 60 months) = $300,000

The maximum price the company would be willing to pay for the new equipment is $300,000. This is equal to the expected labor cost savings over 5 years (ignoring the time value of money).

11.21 Fine Products Manufacturing Company

A. Total variances = $7,900 unfavorable. Because anything greater than $5,000 is considered material, the total variance amount is material.

B. Total WIP, FG, and COGS = $32,000.

Each inventory and COGS account gets a portion of the variance:Work in Process ($2,000/$32,000 x $7,900) $ 494Finished goods ($6,000/$32,000 x $7,900) 1,481Cost of goods sold ($24,000/$32,000 x $7,900) 5,925

Total $7,900


Journal Entry:Work in process inventory 494Finished goods inventory 1,481Cost of goods sold 5,925Direct materials efficiency variance 1,500Variable overhead spending variance 1,000

Direct materials price variance 2,000Labor price variance 5,000Labor efficiency variance 2,000Fixed overhead budget variance 200Variable overhead efficiency variance 1,200

11.22 Pet Toys, Inc.

A.Actual Unit Sales Standardat Standard Prices Contribution Margin

Frisbee 95,000 x $3 $285,000 95,000 x $1.25 $118,750Plush toys 40,000 x $3 120,000 40,000 x $2.00 80,000

Total 135,000 $405,000 $198,750

Revenue budget variance ($450,000 - $409,500) =$40,500 URevenue sales quantity variance ($450,000 - $405,000) = $45,000 USales price variance ($409,500 - $405,000) = $ 4,500 F

B. Standard units sold

At standard sales mixAnd standard CM

(100,00x$1.25+50,000 x $2)$225,000

Actual units sold at actual sales mix and standard CM

(95,000x$1.25 + 40,000x$2)$198,750

Actual units sold at actual sales mix and actual CM

(95,000x$1.55+40,000x$1.40)$203,250

CM sales volume variance($225,000 – $198,750)

= $26,250 U

Contribution margin variance($198,750 - $203,250)

= $4,500 F

Contribution margin budget variance($225,000 - $203,250)

= $21,750 U


C.

Standard units sold at standard sales mix and standard CM

$225,000

Actual units sold at standard sales mix and standard CM

[(130,000 x .67 x $1.25)+(130,000 x .33 x $2)]

$194,675

Actual units at actual sales mix and standard CM

(95,000x$1.25 + 40,000 x $2)$198,750

CM sales quantity variance($225,000 - $194,675)

= $30,325 U

Contribution margin sales mix variance($194,675 - $198,750)

= $4,075 F

Contribution margin sales volume variance($30,325 U + $4,075 F)

= $26,250 U


PROBLEMS

11.23 Raging Sage Coffee

A. For a coffee cart business, workers are scheduled with more help available when the shop is busy, such as in the morning. Although each worker’s hours vary, the schedule remains fairly fixed, so the cost structure includes a high proportion of fixed cost.

B. In this business, workers need to be at the cart regardless of the number of customers. Therefore, the direct labor efficiency variance is meaningless and should not be calculated because it would be measuring whether the clerks sold as many cups of coffee per labor hour as was expected. Labor costs are fixed, so the computation would reflect a revenue variance, rather than a labor efficiency variance.

C. Price variance for coffee beans: Standard cost of actual coffee beans purchased (240 lbs. x $6.00 per lb) $1,440Actual cost of coffee beans purchased 1,800

Price variance $ (360 ) U

Efficiency variance for coffee beans:Coffee beans at standard lbs. (0.04 lbs per cup x 8,260 cups) 330.4 lbsActual beans 224 .0 lbs.

Variance in pounds 106.4 lbs.Standard cost per pound $6 .00

Efficiency variance $638 .40 F

D. The quantity standard for direct labor implies that 20 cups should be sold per hour of clerk/brewer time:

0.05 hours per cup x 60 minutes per hour = 3 minutes per cupIn 60 minutes, 20 cups are expected to be made and sold

Expected sales volume (600 clerk/brewer hours x 20 cups per hour) 12,000 cupsActual sales volume 8,260 cups

Difference between expected volume and actual volume (3,740) cups

E. There is an unfavorable coffee bean price variance, a favorable coffee bean efficiency variance, and sales were off by about 32% (3,740 cups/12,000 cups). These variances might be related. One possibility is that the higher cost of coffee beans caused the clerks/brewers to reduce the quantity of coffee beans used per cup. This would have resulted in weaker coffee, which might have caused customers to go elsewhere.

The following are other possible explanations for the unfavorable sales volume variance:* A competing coffee business opened nearby.* A nearby employer went out of business or launched a major lay-off of

employees.


* There was employee turnover. A clerk/brewer who was well-liked by customers left and was replaced by a clerk/brewer who was often impolite to customers.

* There was road construction nearby, disrupting traffic to the shopping center.* Nearby competitors decreased their selling prices.

F. Instead of basing a bonus based on cost variance measures, give employees a bonus based on profitability. This provides them motivation to encourage customers to return, increasing revenue, and also to contain costs.

11.24 Sunglass Guys

A. Standard overhead rate per direct labor hour:

Calculate total estimated overhead at normal production volume:Estimated overhead = (4,300 x $8.15) + (1,400 x $12.32) + $235,707 = $288,000

Calculate estimated labor hours at normal production volume:Estimated hours = 0.2 x 4,300 + 0.3 x 1,400 = 1,280 hours

Calculate standard rate by dividing estimated cost by estimated hours:Rate = $288,000/1,280 = $225 per direct labor hour

B. This method would be useless for monitoring and control because the fixed and variable overhead costs are not separated. When the production volume variance is commingled with the fixed overhead budget variance and variable overhead spending variances, spending variances cannot be calculated, so no information is available about cost control.

C. The recommendation is to separate fixed and variable overhead costs into separate standards. Only the spending variances will be useful for monitoring and controlling overhead costs.

Using normal monthly volume, the fixed overhead budget variance is:

Estimated fixed overhead cost (i.e., static budget)–Actual fixed overhead cost= $235,707 - $237,859 = $2,152 U

The variable overhead spending variance (using units of production as the allocation base):

Standard variable overhead for actual production–Actual variable overhead cost= ($8.15 * 4,500 Regular units) + ($12.32 * 1,300 Deluxe units) - $54,238= $36,675 + $16,016 - $54,238= $1,547 U


D. To calculate the production volume variance, first determine what the fixed overhead standard rate would have been if it had been calculated separately from the variable overhead standard rate: (See computation of normal labor hours in the solution to Part A.)

Standard fixed overhead costs/Normal number of direct labor hours= $235,707 / 1,280= $184.15 per labor hour

Production volume variance:Standard labor hours for actual production

(0.2 * 4,500 Regular + 0.3 * 1,300 Deluxe) 1,290 hoursNormal labor hours 1,280 hours

Volume variance in labor hours 10 hoursTimes the standard overhead rate $184.14

Production volume variance $1,841 F

Double-check the fixed overhead variance calculations in Parts C and D as follows:

Standard fixed overhead cost allocated to actual production:Regular sunglasses: [($184.15*0.2) * 4,500] $ 165,735Deluxe sunglasses: [($184.15*0.3) * 1,300] 71,819

Total fixed overhead allocated 237,554Less actual fixed overhead costs 237,859

Total fixed overhead variance $ (305) U

Sum of individual variances: [$(2,152) U + $1,841 F] $ (311) UDifference due to rounding

To calculate the variable overhead efficiency variance, the standard volume of allocation base for actual output is compared to the actual volume of allocation base. Because variable overhead is allocated using actual units, an efficiency variance never arises (actual volume of units always equals actual volume of units). Therefore, the efficiency variance will be $0.

E. If labor hours and costs are fixed, they do not vary with production. Therefore, labor hours provide a poor allocation base for variable overhead cost. A better option would be to allocate variable overhead using units produced because the variable overhead costs are more related to units than to labor.

11.25 The Mighty Morphs

A. Documentation price variance for MMMs:

Actual quantity x (standard price per unit – actual price per unit) = [1,005 books x ($3 - $2.95)] +[(825 books x ($5 - $4.75)] = $50.25 F + $206.25 F = $256.50 F


B. Efficiency variance for DVDs

(Standard quantity – actual quantity) x standard price= [(1.03 books per unit x 1,000 units) – 1,005 books] x $3

+ [(1.03 books per unit x 800 units) – 825 books] x $5= (1,030 – 1,005) x $3 + (824 – 825) x $5= $75 F + $5 U = $70 F

C. Labor price variance for both games:(Standard price – actual price) x actual labor hours= ($15 - $795/55) * 55 $ 30 F

Labor efficiency variance for both games:(Standard hours for actual output – actual hours) x standard price= [(0.01 x 1,000) + (0.03 x 800) – 55] x $15= [(10 + 24) – 55] x $15 315 U

Total labor variance $285 U

D. If there were no waste, the company would incur costs for only one DVD and one documentation book per game produced. Thus, the cost of waste is equal to the number of DVDs and documentation books used in excess of one per unit, valued at standard cost:

Waste for DVDs:[Actual DVDs used – (1,000 + 800)] x $0.35= (2,025 – 1,800) x $0.35 $ 78.75

Waste for documentation books:(Actual Power Puffs books used – 1,000) x $3

+ (Actual MMM books used – 800) x $5= [(1,005 – 1,000) x $3] + [(825 – 800) x $5] 140 .00

Total waste $218 .75

E. Pros: It may be less costly to allow waste in the standard than to inspect incoming

materials or to pay for higher quality materials. The company has done it this way a long time, and change might be difficult

for employees.

Cons: Several waste-related opportunity costs arise from defective units. As waste

increases, it is likely that the number of defective units sold increases. Greater defect rates reduce customer satisfaction and reduce sales. By eliminating waste altogether, this cost is avoided.

The company would have saved $218.75, although no information is given about the amount of investment required to save this amount.


11.26 Baker Street Animal Clinic

A. The technicians have argued that the cost variance was caused by the price increase. Thus, the total variance can be separated into a price variance and an efficiency variance.

Normally, the price variance is calculated using the purchase quantity. However, no information is given about the quantity purchased. Also, the problem presents total cost for serum used of $2,270, which results in a $(270) total variance. However, the serum for 2,000 injections costs $105 per 1,000cc. Following are calculations for the price variance.

Price variance for serum:Standard quantity of serum for actual injections 20,000 ccTimes amount of price increase per cc:

[($100/1,000 cc) – ($105/1,000 cc)]= ($.10 - $.105) per cc (.005) per cc

Serum Price Variance (20,000 cc * $.005) $(100) U

Efficiency variance for serum:The efficiency variance cannot be calculated using the usual method because the quantity of serum used is unknown. However, the efficiency variance can be calculated by subtracting the price variance from the total serum cost variance.

Total variance (given in the problem) $(270) UPrice variance (100) U

Serum Efficiency Variance $(170) U

B. The unfavorable efficiency variance represents the cost of wasted serum. To see this, consider the formula for the efficiency variance:

Efficiency Variance = Standard cost * (Standard quantity – Actual quantity)

The difference between the standard quantity and the actual quantity is the amount of serum wasted. At a standard cost of $.10 per cc, the volume of wasted serum is estimated to be 1,700 cc ($170 unfavorable efficiency variance/$.10 per cc).

Is this a significant amount of waste? This is a matter of judgment. Below are several ways to quantity the significance.

Waste, relative to standard quantity of serum:Standard quantity of serum = 2,000 injections * 10 cc 20,000Percent serum waste (1,700 cc/20,000 cc) 8.5%

Note: The waste could also have been calculated using percent of standard cost:$170 efficiency variance/$2,000 standard cost = 8.5%

Number of additional injections that could have been given:Waste of 1,700 cc / 10 cc per injection 170 injections


Following are possible issues to discuss when answering this question:

The percent waste (8.5%) might or might not be considered a significant cost. Given the nature of operations at the Baker Street Animal Clinic, it would be

reasonable for waste to be very close to zero. Had there been zero waste, 8.5% or 170 more injections could have been given. Perhaps the waste is a sign that the technicians are wasteful in other areas, too.

There could be a significant larger problem.

C. The manager would probably be concerned about the unfavorable efficiency variance. The manager could ask the technicians to review their procedures and to identify how and where waste is occurring. Once the reasons for waste are identified, the manager could help the technicians establish new procedures to minimize or eliminate the waste.

If the technicians are unable to provide reasonable explanations for the waste, the manager might become concerned that someone is stealing serum and then selling or using it elsewhere. If the manager considered the cost to be sufficiently large, he/she might institute new procedures for monitoring the physical use of serum. However, this type of approach might cost more than the benefit.

Perhaps the easiest and most cost-effective solution would be to provide the technicians with incentives based on the efficiency variance. The efficiency variance could be used as part of the technicians’ performance evaluation. This would encourage them to seek efficiency improvements on their own.

11.27 Damson Products

[Note: This problem requires students to know about normal versus abnormal waste (see Chapters 5 and 6).]

A. Most of the variances are immaterial and can be closed to cost of goods sold. However, three of them need attention. The $13,000 for materials lost should be accounted for as a flood loss; similarly, the $9,000 in labor should be accounted for as flood loss. This leaves $12,600 - $13,000 = $400 F and $9,700 - $9,000 = $700 U, respectively, in the material efficiency and labor efficiency variances to be closed to cost of goods sold. Note, that variable overhead must not have been allocated on the basis of labor; otherwise, there would be a large unfavorable variable overhead quantity variance.

The production volume variance should also be split into two amounts. The $10,200 due to down time during the flood should be part of the flood loss. The remaining $200 should be debited to cost of good sold.

B. Using the recommendations made in Part A, the journal entries would beCost of Goods Sold $ 658

Material Price Variance $ 658


Flood Loss $13,000Cost of Goods Sold $ 400Material Efficiency Variance 12,600

Labor Price Variance $ 376Cost of Goods Sold $ 376

Flood Loss $ 9,000Cost of Goods Sold 700

Labor Efficiency Variance $ 9,700

Variable Overhead Spending Variance $ 507Cost of Goods Sold $ 507

Cost of Goods Sold $ 412Variable Overhead Quantity Variance $ 412

Fixed Overhead Budget Variance $ 782Cost of Goods Sold $ 782

Cost of Goods Sold $ 200Flood Loss 10,200

Production Volume Variance $10,400

C. The finished goods inventory is unaffected; its balance remains at $34,000.

The net effect of all of the adjustments is a decrease of $95 in cost of goods sold, so the adjusted balance in cost of goods sold is $304,905 ($305,000 – 95).

11.28 Data Processors

[Note: This problem assumes knowledge of ABC (Chapter 7).]

A.Activity Estimated Cost Estimated Activity ABC RateProcessing transactions $2,000,000 5,000,000 $0.40Issuing statements 1,000,000 250,000 $4.00Issuing credit cards 500,000 100,000 $5.00Resolving disputes 90,000 3,000 $30.00


B. The flexible budget in the following statement is calculated by multiplying the actual activity level times the ABC allocation rate (Part A).

Static Actual Flexible ActualActivity Budget Activity Budget Cost VarianceProcessing transactions $2,000,000 5,800,000 $2,320,000 $2,200,000 $120,000 FIssuing statements 1,000,000 270,000 1,080,000 1,300,000 -220,000 UIssuing credit cards 500,000 110,000 550,000 400,000 150,000 FResolving disputes 90,000 3,500 105,000 100,000 5,000 F

$3,590,000 $4,055,000 $4,000,000 $ 55,000 F

C. The spending variance for processing transactions is calculated in Part B as $120,000 F.

D. Budget (i.e., spending) variance for fixed processing costs:At standard (estimated cost) $1,000,000Actual cost 1,300,000

Fixed budget variance $300,000 U

Spending variance for variable processing costs:Actual activity x standard activity rate

(5,800,000 x $1,000,000/5,000,000) $1,160,000Actual cost 900,000

Variable spending variance 260,000 F

Total spending/budget variance for processing costs $ 40,000 U

E. Fixed costs might have increased if new equipment or software was purchased that has not been reflected in the standard. Costs could be out of control. Variable costs might have been reduced if new equipment resulted in more efficient operations. The processes might have been improved somehow. The variance could also reflect normal fluctuations of processing activities.

F. There is no one answer to this part. Sample solutions and a discussion of typical student responses will be included in assessment guidance on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg).


11.29 Software Development Company

[Note: This problem assumes knowledge of budgeting from Chapter 10.]

A. Standard pretax incomeStandard sales

Games 40,000 @ $16 $640,000Business 2,000 @ $55 110,000Educational 10,000 @ $20 200,000

Total sales 950,000Standard variable costs 52,000 @ $2 (104,000)Standard fixed costs (535,000)

Standard pretax income $311,000

Average contribution margin per unit per master budget:

40,000 x $14 + 2,000 x $53 + 10,000 x $18 = $16.26923152,000

Average standard contribution margin per unit for actual sales:

35,000 x $14 + 4,000 x $53 + 11,000 x $18 = $18.0050,000

Master budget pretax income $311,000.00Sales quantity variance (52,000 - 50,000)*$16.269231 (32,538.46)Contrib. margin sales mix variance ($16.269231 - $18)*50,000 86,538 .46

Flexible budget pretax income 365,000.00Sales price variance:

Games ($16 - $616,000/35,000)*35,000 56,000.00Business ($55 - $198,000/4,000)*4,000 (22,000.00)

Material price variance ($2 - $106,575/50,750)*50,750 (5,075.00)Material quantity variance (50,000 - 50,750)*$2 (1,500.00)Fixed cost budget variance ($535,000 - $533,500) 1,500 .00

Actual pretax income $393,925 .00

B.1. The sales manager should be held responsible for only those variances related to

activities under his or her control. Therefore, the production-related variances (material price and material quantity) should be excluded. The fixed cost budget variance should be considered only to the extent that the fixed costs are under the sales manager’s control. The sales manager is mostly likely responsible for some fixed costs, so a budget variance for those costs should be separated from the budget variance for other costs. The group of sales-related variances, considered together, provides information to evaluate whether the sales managers’ changes to prices and sales effort are benefiting the company. Although individual variances such as sales quantity and sales price may be negative, the important question is whether the sales manager’s new strategies are increasing the company’s profits.


2. The manager should be praised. The net effect of the manager's changes can be seen in the sales mix, quantity, and price variances. These variances total to an $88,000 favorable variance ($32,538.46 U + $86,538.46 F + $56,000.00 F + $22,000.00 U).

C. SalesGames (55,000*35,000/50,000) @ $17.60 $ 677,600Business (55,000*4,000/50,000) @ $49.50 217,800Educational (55,000*11,000/50,000) @ $20.00 242,000

Total sales 1,137,400Variable costs 55,000 @ $1.80 99,000Fixed costs 535,000

Pretax income $ 503,400

D. The managers cannot know for certain whether there will be changes in customer preferences that affect the demand estimates. They also cannot know for certain when prices of inputs will increase. Although they can build known price changes into the budget, even vendors may not anticipate their own price increases up to a year in the future. The managers cannot know their costs for services such as electricity and transportation because these prices are affected by weather and gas and oil costs. There are many uncertainties that cannot be perfectly predicted; these are just a few examples.

11.30 Professor Grader

A. It is not possible to develop a perfect system for measuring student performance in a course. To know for certain the amount of effort put forth, and the understanding that each student acquires, a professor would have to monitor all of their actions related to the course, no matter where the student was. This is impossible. Even if it were possible to perfectly observe all student actions, uncertainty would still exist about how best to measure individual course performance. Should students be graded based on the improvement in their knowledge and other competencies during the course? Should they be graded based on an absolute standard for the course? Should grades be measured relative to other students in the same section or several sections taught by the professor?

B. There is probably wider variation in exam results than any of the other measures, but because some students have access to the exam, variation is reduced. There is probably very little variation in attendance because it is rarely monitored. There is probably little variation in the term paper because it is graded on quantity, not quality, and the quantity standards are known by all students. There is probably little variation on the take-home exam because students have two weeks to work on it, and judging from other aspects of this professor’s performance evaluation systems, it is likely that all of the questions have single correct answers because they are easy to grade.

C. As a performance measurement system, the grading system is faulty for several reasons.

The performance standard appears to be very low. Students will not be motivated to work hard to learn the subject matter of the course.


The performance measurement for the term paper does not seem to be consistent with the goals of the course. Measuring length instead of content would normally not measure whether students understood the subject matter of the course.

There is no feedback on the midterm exam. Consequently, students are not apprised of whether they are meeting the standards of the course. They have no basis for changing their actions to improve future performance.

The performance measure is unfair to the extent that some students have access to the midterm exam and others do not.

It is questionable whether a student’s performance on the final exam provides information about overall performance. The potential for manipulation (having someone else work the final) is high.

The defects in the performance measure are so severe that one should not attempt to use grades earned in this course as a measure of students' comprehension of the subject matter.

D. Professor Grader has a responsibility to students and to others who directly finance students (such as parents and spouses) to grade in a manner that is consistent with university and program policies and also with the grading system set forth in the course syllabus. The professor is also responsible for establishing a grading system that is fair to students in the course and that measures student learning (although how to do this is uncertain, as described in Part A). This group of stakeholders often considers grades as signals about student effort and/or ability. If the grades do not measure student effort or ability, even with error, these stakeholders do not have adequate information about the student’s progress.

Professor Grader has responsibilities toward the recruiters who hire the university’s graduates. Recruiters want to identify students who work hard and learn new things quickly. Grades measure these skills and abilities, although with error. Without appropriate measurement, recruiters cannot identify students that might best suit their needs, and they may no longer use the university for recruiting.

Professor Grader is responsible to the university, which expects professors to ensure that graduating students have met outcomes specified by the university, such as the ability to think critically, communicate effectively, be an effective team member, and are knowledgeable within their respective majors. Universities rely on professors and their evaluation systems to maintain standards.

Professor Grader is responsible to other professors at the university, who rely on their colleagues to grade fairly so that students develop a better understanding of expectations and are do not become unhappy about discrepancies in grades across courses or sections of courses.


Professor Grader is responsible to state and federal governments and their citizens, who financially support the university, for using resources efficiently. The professor is responsible to these stakeholders for ensuring that the grading system encourages greater student learning. The professor also has a responsibility to the general public for improving the education of its citizens.

E. There are a variety of ways to answer this question. In general, however, Professor Grader does not appear to have acted ethically in this situation because the professor does not appear to have adequately addressed the responsibilities described in Part D. The professor appears to have placed low priority on values such as integrity, fairness, and professional competence.

F. It is unethical for students to cooperate on the take-home exam if Professor Grader has specifically asked them not to do that. It is also unethical for students to have access to an exam that is not public information. Some students in the class will act ethically because they have high ethical standards. It is unfair to these students when other students do no behave ethically.

Some students in this situation might rationalize unethical behavior by saying that “Everyone is doing it,” or “The professor should expect us to get all the help we can.” These types of rationalizations are simply ways of avoiding ethical responsibility. Although the professor’s system might contribute to unethical behavior, the system does not justify unethical behavior.

A variety of values could be used to reach the conclusions drawn above. For example, the values of fairness, honesty, and integrity would lead students to behave ethically in this situation.

11.31 Benerux Industries

A. Managers cannot perfectly observe employee effort and abilities. Therefore, it is impossible to perfectly measure, monitor, and motivate employee performance.

B. The first part of the performance measurement system allows company managers to learn whether the company’s production levels this year are 5% higher than production levels during the same month of the prior year.

The second part of the performance measurement system allows the managers to learn whether actual cost per unit is higher or lower than the average cost for manufacturing this kind of product as determined from industry newsletters.

C. In companies that value quality, price and efficiency variances may not be as important as information about quality. If the company’s strategy is to be the highest quality manufacturer, and the market is willing to pay more for higher quality, the company may emphasize quality and may not emphasize cost control and efficiency.


D. The proposed performance measurement report suffers from several major weaknesses.

It concentrates on the wrong goals--quantity and cost. The firm has achieved its success through quality.

The volume measure is susceptible to easy manipulation. Production employees could presumably start a large number of units with virtually no effort. This would increase the amount of WIP on hand and increase inventory carrying costs.

The performance standard on quantity is arbitrary (5% increase). It seems unrelated to sales and may encourage the accumulation of excess inventory.

The performance standard for cost is incorrect. The firm is producing a higher quality product than other firms in the industry. Consequently, the firm should expect higher costs than other firms.

Even if the reports were appropriate, a quarterly report is unlikely to provide sufficiently timely feedback to allow workers to adjust their performance to achieve budgeted goals.

Workers are likely to resent the new system and could then leave the company, requiring increased costs in training and reduced productivity.

E. There is no single answer to this question. However, the answer should contain a synthesis of the issues discussed in the preceding sections, and it should also address concerns about responding in a productive way to the new accountant. The following major areas should be addressed:

A summary of what the proposed system would measure (Part B) and the weaknesses in the proposal (Part D), followed by a conclusion about whether the CFO would support the proposal. Most likely, the CFO would not be in favor of the proposal because it focuses on inappropriate measures.

A discussion of whether a new performance measurement system would be useful for this company. This discussion would address possible reasons why variances are not currently used (Part C), followed by a conclusion about whether some type of new performance measurement system should be considered. One possible conclusion would be that no apparent reason currently exists to make a change. The company’s current control system seems to be working fine, so there may be no reason to consider changing it. An alternative conclusion might be that it would be useful for the company to investigate possible alternative performance measures. Even if the company’s system is working fine, there may be ways to improve it or to prevent unforeseen future problems; a performance measurement system might be useful.

Identify ways to respond to the new accountant. The response should be positive so that it encourages the accountant to continue to think creatively and to share


new ideas. The response is also a learning opportunity for the new accountant. The CFO could discuss the proposal with the cost accountant and ensure that the accountant understands the proposal’s flaws. They could then discuss ways to improve upon the ideas in the proposal.

11.32 Auto Parts Co.

A sample spreadsheet showing the calculations for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg).

A. Below is an excerpt from a sample spreadsheet for this problem. For variable costs, the flexible cost budget should reflect the actual volume, or 950 pistons. Because fixed costs are not expected to vary with production volume, they are presented using the static budget amount. The problem information indicates that direct labor is a fixed cost. Also, notice that the allocation base for variable factory overhead is direct labor hours.

The problem does not give the total standard amount of fixed direct labor cost or fixed factory overhead, but they can be calculated from the standard cost information:

Fixed direct labor (1,000 pistons x $6 per piston) $ 6,000

Fixed factory overhead (1,000 pistons x $20 per piston) 20,000

B. The direct costs consist of: piston shafts, shaft housings, and direct labor. Because the information in the problem indicates that actual costs were identical to standard costs for shaft housings, there are no variances for shaft housings. Therefore, direct cost variances are calculated only for piston shafts and direct labor. Also note that direct labor in this problem is treated as a fixed cost. Accordingly, budget and volume variances are calculated for direct labor using the same method that is used for fixed factory overhead. Below is an excerpt from a sample spreadsheet showing the direct cost variances for this problem.


Double-check computations for total piston shaft variances:

Standard cost for quantity of pistons produced (950*$35) $33,250Actual cost for piston shafts purchased $(34,950)Increase in cost of raw material inventory:

Quantity purchased 1,000Quantity used 954

Increase in inventory quantity 46Standard cost per piston shaft $ 35

Book value of raw material inventory increase 1,610Actual cost of pistons used in production (33,340)Total piston shaft variance $ (90) U

Sum of price and efficiency variances [$50 + $(140)] $ (90) U

Double-check computations for direct labor variances:

Standard cost for quantity of pistons produced (950*$6) $ 5,700Actual direct labor cost (6,120)Total direct labor variance $ (420) U

Sum of direct labor budget and volume variances [$(120)+$(300)] $ (420) U


C.

Double-check computations for variable overhead variances:

Standard cost for quantity of pistons produced (950*$4) $ 3,800Actual variable overhead cost (3,677)

Total variable overhead variance $ 123 F

Sum of spending and efficiency variances [$293+$(170)] $ 123 F

Double-check computations for fixed overhead variances:

Standard cost for quantity of pistons produced (950*$20) $ 19,000Actual fixed overhead cost (18,325)

Total fixed overhead variance $ 675 F

Sum of budget and volume variances [$1,675+$(1,000)] $ 675 F

D. Below is an excerpt from a sample spreadsheet showing the total selling and administrative variance for this problem.


E. Before preparing a report that would be useful in evaluating control of production costs, identify costs that are relevant to production: direct costs and factory overhead. The selling and administrative costs are not relevant. Next, identify the relevant variances for evaluating production costs: the price and efficiency variances for direct materials, the spending variance for direct labor (because it is a fixed cost) and variable overhead, and the budget variance for fixed overhead costs. The variable overhead efficiency variance is not relevant because its information is already provided by the direct labor efficiency variance. The direct labor and production volume variances are not relevant because total volume is assumed to be driven by sales rather than by the production department.

Below is an excerpt from a sample spreadsheet showing a production cost variance report for this problem.

The actual cost for piston shafts was calculated in Part B.

F. The production cost variances would be closed using the method shown on pages 437-438 in the textbook. The first step is to sum all of the production cost variances and determine whether they are material. Below is an excerpt from a sample spreadsheet computing the net amount of all production cost variances.

The second step is to compare the total net amount of production cost variances ($288 F) with total actual production costs ($80,462). In this case, the variances amount to only


0.4% of actual costs. Therefore, the variances would be considered immaterial, and the adjustment would be made entirely to cost of goods sold.

The adjusting journal entry would be made as follows:

Piston shafts direct materials price variance 50Variable overhead spending variance 293Fixed overhead budget variance 1,675

Piston shafts direct materials efficiency variance 140Direct labor spending variance 120Direct labor volume variance 300Variable overhead efficiency variance 170Production volume variance 1,000Cost of goods sold 288

G. As manager of the piston division, I would like to know if the quality of the pistons was the same as usual. Four more pistons were used than expected, so it is possible that quality has been compromised with a lower price. This could be a problem if defective shafts are not removed from production and customers receive more defective pistons than usual. Sales volumes could drop. I would also like to know why labor costs and hours were up. If workers had to work overtime because of a quality problem, cost and hours would be up. It appears that fixed and variable overhead costs were under control, and were even less than expected during the period. Because the fixed overhead budget variance is fairly large, I would want to know if something has changed and whether the use of overhead has improved. If so, the standard could be changed, although the efforts of workers to reduce fixed costs needs to be recognized and praised.

11.33 Bramlett Company

A. The problem states that management wants to maintain the selling price for several years, so the assumption is made that long-run standard costs will be used for pricing, rather than the expected costs during start up.

Standard cost per unitDirect materials 4 pieces @ $20 $ 80Direct labor 10 hours @ $25 250Variable overhead 50% x $250 125Fixed overhead (a) 42.666% x $250 107

Total 562Markup 60% x $562 337Selling price $899

(a) After start up, the firm will produce 1,500 units per month, or 18,000 per year. The budgeted labor costs for 18,000 units is 18,000 x $250 = $4,500,000. Using the same basis to allocate fixed overhead as is used to allocate variable overhead yields a fixed overhead rate of $1,920,000/$4,500,000 = 42.666% of labor cost.


B. The variances for product costing purposes using the long-term standards would be

Labor price variance(Standard price – actual price) x actual hours= ($25 - $26) x 12,000 = $12,000 U

Labor efficiency variance(Standard quantity for actual output – actual quantity) x standard price=[(10 x 950) - 12,000] x $25 = $62,500 U

For product costing purposes, the overhead variances would be as follows (note that overhead is based on labor cost, not hours):

Variable overhead spending variance= Actual allocation base (labor cost) at standard rate – actual variable

overhead= [(50% x $312,000) - $160,250 = $ 4,250 U

Fixed overhead budget varianceStatic budget for fixed costs (budgeted fixed overhead per month) – actual

fixed overhead= [($1,920,000/12 - $172,220] = $160,000 - $172,220 = $ 12,220 U

Variable overhead efficiency variance= Standard allocation base at standard rate – actual allocation base at

standard rate = (Standard labor cost – actual labor cost) x standard variable rate = [($25 x 10 hours x 950 units) - $312,000] x 50% = $37,250 U

Production volume variance= Standard allocation base at standard rate (allocated cost) – estimated

allocation base at standard rate (static budget)= (Standard labor cost for actual output – standard labor cost for estimated

output) x standard rate = [($25 x 10 hours) x (950 units - 1,500)] x 0.42666 = ($237,500 - $375,000) x 0.42666 = $58,666 U

C. Here are some pros and cons for using the long-term standard for the first month’s operations.

Pros: The accounting department performs the calculations they will use for the next

year, and personnel will gain experience with the new system The variances will reflect the results of the long-term standard and give workers a

more accurate picture of the gaps in their performance Using the long-term standard may highlight areas with very large variances that

are likely to have larger variances over the next few months


Cons: Workers may be discouraged when their performance is compared to such high

standards The standard will not be viewed as realistic, and so may be ignored causing

poorer performance in the first few months than otherwise Information about variances from these standards is of poor quality and cannot be

used reliably for planning or monitoring

D. The short term standards do not affect the labor price variance. It remains the same as above:

Labor price variance=(Standard price – actual price) x actual hours= ($25 - $26) x 12,000 = $12,000 U

However, a substantial portion of the labor efficiency variance was anticipated. That is, management expected it to take 10 x 1.2 = 12 hours per unit during the first month of operations. The following variance better reflects performance.

Labor efficiency variance = [(12 x 950) - 12,000] x $25 = $15,000 U

The overhead spending and budget variances are probably unaffected by the learning curve experienced by labor. Therefore, they are the same as in part B, as follows.

Variable spending variance= Actual allocation base (labor cost) at standard rate – actual variable overhead= [(0.5 x $312,000) - $160,250 = $ 4,250 U

Fixed overhead budget variance= Static budget fixed costs (budgeted fixed overhead per month) – actual

fixed overhead= [($1,920,000/12 - $172,220] = $160,000 - $172,220 = $ 12,220 U

The following variances are used as adjusting entries in the accounting records. It may be more appropriate for these variances to reflect the expected short-term performance as well. Therefore they could be calculated as follows.

Variable overhead efficiency variance= [($25 x 12 x 950) - $312,000] x 0.5 = $13,500 U

Production volume variance= [($25 x 12 x 950) - ($25 x 12 x 1,000)] x 0.5333 = ($285,000 - $300,000) x 0.5333 = 8,000 U


Where the adjusted fixed overhead rate is calculated as:Monthly fixed overhead = $1,920,000/12 = $ 160,000Anticipated labor costs = ($25 x 12 x 1,000) = $300,000Rate based on anticipated activity = $160,000/$300,000 = 53.33%

E. Following are several possible reasons for the variances. Students may think of others.

1. Direct labor price variance: Because labor used more hours, overtime may have been paid. In addition, it is possible that workers with higher skill levels were hired. It is also possible that the standard is too low, that labor rates increased during the month.

2. Direct labor efficiency variance: The standard may be wrong because workers have so little experience at this new plant, the company may still be experiencing a learning curve, or labor may be working inefficiently for some reason such as lack of training, high absenteeism, or just low productivity.

3. Variable overhead spending variance: Because this was the first month, it is possible that some costs were higher than anticipated. For example, the company may expect to receive volume discounts on indirect materials, but does not earn them until order sizes become as large as anticipated. Indirect labor may have had to work extra hours and received overtime pay. There may have been more maintenance on machines than anticipated during the start-up period.

4. Fixed overhead budget variance. It is possible that utilities were higher than anticipated due to season or weather-related factors. The standard may be too low because accountants did not anticipate all of the fixed costs. Some periodic costs such as taxes or insurance may have been paid this month.

F. Managers respond to variances according to the results of their investigations. If they find the standard is wrong, they change the standard. For example, it is likely that some of the standards at Bramlett will need adjusting as the company obtains more experience with the new product. If managers find that operations are out of control, they will monitor operations more closely and ask employees for suggestions to improve performance. If managers realize that the variances for this month are based on long-term standards, they may do nothing because they believe that over the next few months the variances will disappear. If managers discover that labor variances are related to employee turnover or absence, they may use compensation incentives based on attendance or longevity to improve this aspect of operations. However, increasing compensation will also increase labor costs, so the costs and benefits of these types of alternatives need to be analyzed. Students may have thought of a number of different ways that managers respond to the variance information.

G. Because uncertainties exist about the appropriate amount for standards, it would probably be more difficult to analyze the variances at the new plant. It will take a number of months before production at the new plant becomes stable. At that time it will be easier to set standards because accountants will know more about regular operations, and most of the learning will have taken place, so results are less likely to be affected by learning curves.


BUILD YOUR PROFESSIONAL COMPETENCIES

11.34 Focus on Professional Competency: Interaction

A.1. An accountant’s role in developing standards, analyzing variances, and

recommending actions varies from organization to organization, depending on the nature of the business and the organizational structure. In some organizations, engineers or quality control personnel handle these activities. In other organizations, accountants gather information, perform calculations, and develop forecasts that are used in creating standards. They also gather information about large or important variances, analyze their causes, and then recommend appropriate actions.

2. Accountants must work with others in the organization to perform the tasks described in Part A.1 above. For example, they gather information from people who work in the operating areas for which standards are developed as well as from other personnel in areas such as engineering, human resources, and purchasing. Ideally, they work as partners with managers in various departments to help them develop reasonable standards and improve operations over time.

B.1. Attainable standards are standards that should be achievable by employees, given

existing or planned operating processes. Slack is an allowance built into standards to permit deviation from “perfect” performance. Standards are more likely to be attainable if they contain some slack to allow normal variation in cost and efficiency. However, standards having too much slack fail to motivate employees to achieve better results.

Managers cannot know for certain whether standards are reasonable because it is difficult or impossible to measure the level of achievable performance. Information about past performance and measures built on that performance could include slack. Studies of performance are sometimes unreliable because employees may perform poorly knowing that a standard will be developed based on their performance. Also, higher levels of performance may be achievable for short time periods, but might not be sustainable over long time periods.

2. Different students will provide different examples from their own experiences. Team protocols and expectations are sometimes communicated explicitly, but they may also be implicit. New members to a team often learn about protocols by asking questions and by observing team behavior.

3. Production employee incentives are similar to the incentives discussed in Part B.1 for all employees. Standards can motivate employees to work harder and more efficiently to achieve explicit goals. However, employees are more likely to work toward standards they perceive as achievable. When standards are too difficult to achieve, employees may give up and not attempt to meet them.


C.1. Some people believe that cooperation means giving in to others. Instead, true

cooperation involves listening carefully to others’ perspectives, attending to diverse interests, and working together to reach the best overall result. Thus, cooperation should encourage free expression rather than discourage it.

2. Each student will have his or her own experiences to share when answering this question. The purpose is to help students reflect on what constitutes useful coaching/mentoring.

11.35 Integrating Across the Curriculum: Auditing

A. There are many possible errors that could cause a variance even when no variance actually exists. Below are possible answers to this question; students may think of others.

Direct materials price: The company has a policy of using the net method for recording early payment discounts, but an accountant erroneously recorded the purchase transaction using the gross method. Then when payment was made, a credit was erroneously recorded to a miscellaneous income account instead of to the cost of direct material purchases. This combination of errors would cause the cost of direct materials purchased to be overstated.

Direct materials efficiency: A mechanical error could have occurred in recording the quantity of direct materials used in production. For example, a clerk might have accidentally entered a quantity of “975” instead of “957,” overstating the quantity of direct materials used.

Direct labor price: A payroll department employee made an error when entering the pay rate for an individual production employee in the payroll system. This error would cause the employee to be overpaid or underpaid, which in turn would overstate or understate direct labor cost.

Direct labor efficiency: A production employee accidentally miscoded her time, causing hours to be charged to direct labor instead of indirect labor. This error would overstate direct labor hours and understate indirect labor hours (in either variable or fixed overhead cost).

Variable overhead spending: When making an entry to record the transfer of indirect materials from the warehouse to production, a clerk accidentally coded the materials as direct materials instead of indirect materials. This error would overstate direct material costs and understate variable overhead costs.

Variable overhead efficiency: An error in the accuracy of the variable overhead cost allocation base would also cause an error in this variance. For example, if the cost allocation base is either direct labor hours or direct labor costs, then the errors described above for direct labor efficiency or direct labor spending would cause an error in the variable overhead efficiency variance.


Fixed overhead budget: An accounting clerk might have accidentally coded a fixed overhead cost as a variable overhead cost. This error would cause fixed overhead costs to be overstated and variable overhead costs to be understated.

Production volume: An error in the computation of units produced would cause an error in this variance. Suppose personnel forget to record the number of units spoiled during a particular production run. This error would cause the number of good units produced to be too high, overstating the production volume.

B. The theft of inventory is accounted for with any other errors in inventory quantities at the time physical inventory is counted. Because it is not possible to distinguish between theft and errors, the adjustment for missing raw materials inventory is usually recorded as either direct materials or indirect materials (most likely in variable overhead). If the adjustment is recorded to direct materials, then the theft would be reflected in the direct materials efficiency variance (the usage of raw materials would appear to be higher). If the adjustment is recorded to indirect materials, then the theft would overstate variable overhead costs, which would be reflected in the variable overhead spending variance.

C. There are several reasons for failing to uncover theft through analysis of the affected variances. Variances include offsetting positive and negative items, and the theft might be offset by positive variances such as more efficient use of materials. In addition, cost standards are often set based on past experience. If the company has always experienced significant theft, then the cost would already be anticipated in the cost standards.

D. Assuming that the fictitious employee time is charged to direct labor, this fraud would be reflected in the direct labor efficiency variance. If the pay rate for the fictitious employee is not equal to the standard direct labor pay rate, then the fraud would also be reflected in the direct labor price variance. If time for the fictitious employee is charged to an overhead account, then this fraud would be reflected in the variable overhead spending variance or fixed overhead budget variance.

E. This error will cause variable overhead costs to be overstated this year by the difference between the total cost and the amount that should have been depreciated this year. Variable overhead costs will be understated in future years by the amount of depreciation that should have been recorded. This error would be reflected in the variable overhead spending variance. During the current year the variance would be less favorable (or more unfavorable), and in future years it would be more favorable (or less unfavorable).

F. The most obvious way to increase earnings by misapplying accounting principles for variances is to close material variance accounts incorrectly. For example, favorable variances could be closed to cost of goods sold instead of prorated to cost of goods sold and work in process.