A just-in-time (JIT) approach combined with total quality management (TQM), as discussed in Chapter 19, can reduce or eliminate many unfavorable cost variances. For instance, long- term pricing agreements with a select group of suppliers can virtually eliminate materials price variances. Materials usage variances caused by defective materials also may be mini- mized. Should a batch of inferior materials be encountered, the production process is halted and the supplier is contacted to resolve the problem immediately. Thus, rather than discover- ing quality control problems after the fact, using JIT and total quality control makes it possible to detect and correct quality problems as they occur.
Workers in a JIT system must be able to shift production quickly from one product to another. Adherence to carefully planned production schedules reduces idle time and elimi- nates non-value-added activities. As a consequence, labor efficiency variances often are improved under a JIT approach.
Well-trained employees, working smarter and more efficiently, can minimize the need for overtime hours. Thus, JIT systems may reduce or eliminate unfavorable labor rate variances.
Finally, by cutting overhead costs associated with non-value-added activities, JIT and TQM systems also help management avoid unfavorable overhead spending variances.
Concluding Remarks
We have illustrated that cost information is not just for cost accountants. Indeed, it affects virtually every aspect of business operations. At Brice, the savings from purchasing inexpen- sive materials made the purchasing department look good but created cost overruns and other problems throughout the organization.
While a cost accounting system does not solve such problems, it can bring the many dimensions of the problem promptly to management’s attention.
Concluding Remarks
W h ill t t d th t t i f ti i t j t f t t t I d d it ff t
You are the plant manager for Brice. You have recently implemented a bonus system for your employees that provides a 10 percent bonus for favorable variances. What are the potential benefits, costs, and ethical concerns of such a bonus system?
(See our comments on the Online Learning Center Web site.) Y O U R T U R NY O U R T U R N You as a Plant Manager
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Ethics, Fraud & Corporate Governance
For companies that use standard costing systems, the accuracy of the inventory and cost of goods sold figures reported in their financial statements depends upon the reliability of these standard cost numbers. A company’s financial statements can be materially misstated when standard costs do not accurately represent the actual manufacturing costs incurred.
The Securities and Exchange Commission (SEC) brought an enforcement action against NCI Building Systems, Inc., in regard to a material overstatement of reported income that was largely due to erroneous standard cost amounts assigned to inventory. NCI is a manufacturer and distributor of metal building components and engineered building systems, and its stock is traded on the New York Stock Exchange.
NCI ’s senior management noted an unusually high inventory balance in its Components Division. Even though senior management instructed the Components Division to stop purchasing steel, NCI ’s inventory balance did not decrease by the expected amount. NCI took a physical inventory to compare the actual inventory on hand with the inventory balance per the accounting records. The inventory balance per the accounting records was $15–$18 million greater than the physical inventory amount. This
overstatement of inventory had the effect of understating cost of goods sold and, therefore, overstating net income.
The overstatement of inventory was largely due to problems with NCI ’s standard cost system. NCI ’s manufacturing process generated a nontrivial amount of scrap, but NCI ’s standard cost was inadequate to account for all of the scrap material that was generated during the manufacturing process.
As a result, the value of scrap material was included as usable inventory, which had the effect of overstating the inventory balance.
An interesting side note to this case is how NCI ’s management handled these accounting problems. First, NCI retained its outside accounting firm to investigate the large difference between the book and physical inventory amounts. Second, NCI promptly restated its previously issued financial statements. Third, significant remedial measures were put in place to reduce the likelihood of such errors in the future. Fourth, a number of NCI ’s accounting personnel were terminated. Finally, NCI cooperated fully with the SEC in its investigation of this matter. As a result of these factors, which were specifically referred to by the SEC in its written enforcement release, the sanction imposed on NCI for its violation of the securities laws was relatively mild.
Summary of Cost Variances For your convenience, the six cost variances dis- cussed in this chapter are summarized in Exhibit 24–9 .
Exhibit 24–9 SUMMARY OF VARIANCE COMPUTATIONS AND MANAGER RESPONSIBILITIES
Variance Computation Manager Responsible Materials:
Price variance Actual Quantity (Standard Price Actual Price) Purchasing agent
Quantity variance Standard Price (Standard Quantity Actual Quantity) Production manager
Labor:
Rate variance Actual Hours (Standard Hourly Rate Actual Hourly Rate) Production manager Human resource manager Efficiency variance Standard Hourly Rate (Standard Hours Actual Hours) Production manager Overhead:
Spending variance Budgeted Overhead (at Actual Production Level) Actual Production manager
Overhead (to extent variance
relates to control-
lable costs)
Volume variance Applied Overhead (at Standard Rate) Budgeted None—this variance
Overhead (at Actual Production Level) results from
scheduling production
at any level other than “normal”
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END-OF-CHAPTER REVIEW
S U M M A R Y O F L E A R N I N G O B J E C T I V E S
Define standard costs and explain how they assist managers in controlling costs. Standard costs are the expected (or budgeted) costs per unit. When standard costs are used in a cost accounting system, differences between actual costs and standard costs are promptly brought to management’s attention using a schedule of differences called variances.
Explain the difference between setting ideal stan- dards and setting reasonably achievable standards.
The most widely used approach is to set budgeted amounts at levels that are reasonably achievable under normal operating conditions. The goal in this case is to make the cost standard a fair and reasonable basis for evaluating performance.
An alternative is to budget an ideal level of performance.
Under this approach, departments normally fall somewhat short of budgeted performance, but the variations may identify areas in which improvement is possible.
Compute direct materials and direct labor variances and explain the meaning of each. Cost variances are computed by comparing actual costs to standard costs and explaining the reasons for any differences. Differences in the cost
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of materials used may be caused either by variations in the price paid to purchase materials or in the quantity of materials used.
Differences in the cost of direct labor may be caused by variations in wage rates or in the number of hours worked.
Compute overhead variances and explain the meaning of each. To compute overhead cost variances, compare the actual overhead to the budgeted overhead and compare the budgeted overhead to the applied overhead.
Cost variances can result from spending more than budgeted or from a difference between the projected volume used to create the overhead application rate and the actual production used to apply overhead.
Discuss the causes of specific cost variances. Mate- rials variances may be caused by the quality and price of materials purchased and by the efficiency with which those materials are used. Labor variances stem from workers’
productivity, pay scales of workers placed on the job, and the quality of the materials with which they work. Overhead variances result both from actual spending and from differences between actual and normal levels of production.
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Key Terms Introduced or Emphasized in Chapter 24
fixed manufacturing cost (p. 1041) A manufacturing cost that, in the short run, does not vary in response to changes in the level of production.
labor efficiency variance (p. 1044) The portion of the total labor variance caused by a difference between the standard and actual number of labor hours required to complete the task. Com- puted as Standard Hourly Rate (Standard Hours Actual Hours). Also called labor usage variance.
labor rate variance (p. 1044) The portion of the total labor variance caused by a difference between the stan- dard hourly wage rate and the rate actually paid to workers.
Usually stems from overtime or using workers at a different pay scale than assumed in developing the standard cost. Com- puted as Actual Hours (Standard Hourly Rate Actual Hourly Rate).
materials price variance (p. 1043) The portion of the total materials variance caused by paying a different price to purchase materials than was assumed in the standard cost. Computed as Actual Quantity (Standard Unit Price Actual Unit Price).
materials quantity variance (p. 1043) The portion of the total materials variance caused by using more or less material in the
production process than is called for in the standard. Computed as Standard Unit Price (Standard Quantity Actual Quantity).
spending variance (p. 1046) The portion of the total over- head variance caused by incurring more overhead costs than are allowed for the actual level of activity achieved.
standard cost (p. 1038) The budgeted cost that should be incurred under normal, efficient conditions.
standard cost system (p. 1038) A system that accumulates product, service, or process costs using standard input prices and quantities.
variable manufacturing cost (p. 1041) A manufacturing cost that varies in approximate proportion to the number of units produced.
variance (p. 1038) A difference between the actual level of cost incurred and the standard (budgeted) level for the cost. The total cost variance may be subdivided into separate cost vari- ances indicating the amount of variance attributable to specific causal factors.
volume variance (p. 1046) The portion of the total overhead variance that results from a difference between the actual level of production and the “normal” level assumed in computing the standard unit cost. In effect, the volume variance is a misalloca- tion of fixed overhead costs and often is not relevant in evaluat- ing performance.
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Demonstration Problem
Krueger Corporation recently implemented a standard cost system. The company’s cost accountant has gathered the following information needed to perform a variance analysis at the end of the month:
Demonstration Problem
Standard Cost Information
Direct materials . . . $5 per pound Quantity allowed per unit . . . 100 pounds per unit Direct labor rate . . . $20.00 per hour Hours allowed per unit . . . 2 hours per unit Fixed overhead budgeted . . . $12,000 per month Normal level of production . . . 1,200 units Variable overhead application rate . . . $ 2.00 per unit Fixed overhead application rate ($12,000 1,200 units) . . . 10.00 per unit Total overhead application rate. . . $12.00 per unit Actual Cost Information
Cost of materials purchased and used . . . $468,000 Pounds of materials purchased and used . . . 104,000 pounds Cost of direct labor . . . $46,480 Hours of direct labor . . . 2,240 hours Cost of variable overhead . . . $2,352 Cost of fixed overhead . . . $12,850 Volume of production . . . 1,000 units
Instructions
a. Compute the direct materials price variance, given an actual price of $4.50 per pound ($468,000 104,000 pounds).
b. Compute the materials quantity variance, given a standard quantity of 100,000 pounds allowed to produce 1,000 units (1,000 units 100 pounds per unit).
c. Prepare a journal entry summarizing the cost of direct materials charged to production.
d. Compute the labor rate variance, given an actual labor rate of $20.75 per hour ($46,480 2,240 hours).
e. Compute the labor efficiency variance.
f. Prepare a journal entry summarizing the cost of direct labor charged to production.
g. Compute the overhead spending variance.
h. Compute the overhead volume variance.
i. Prepare a journal entry summarizing the application of overhead costs to production.
Solution to the Demonstration Problem
a. Materials Price Variance Actual Quantity Used (Standard Price Actual Price)
104,000 pounds ($5.00 $4.50)
$52,000 Favorable
b. Materials Quantity Variance Standard Price (Standard Quantity Actual Quantity)
$5.00 per pound (100,000 104,000)
$20,000 (or $20,000 Unfavorable)
c.
Work in Process Inventory (at standard cost). . . 500,000*
Materials Quantity Variance (unfavorable) . . . 20,000
Materials Price Variance (favorable) . . . 52,000 Direct Materials Inventory (at actual cost). . . 468,000 To record the cost of direct materials charged to production.
*1,000 actual units 100 pounds allowed per unit $5 per pound $500,000.
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Self-Test Questions 1055
d. Labor Rate Variance Actual Labor Hours (Standard Rate Actual Rate)
2,240 hours ($20.00 $20.75)
$1,680 (or $1,680 Unfavorable)
e. Labor Efficiency Variance Standard Rate (Standard Hours Actual Hours) $20 (2,000 hours* 2,240 hours)
$4,800 (or $4,800 Unfavorable)
*1,000 units 2 hours per unit.
f.
Work in Process Inventory (at standard cost) . . . 40,000*
Labor Rate Variance (unfavorable) . . . 1,680 Labor Efficiency Variance (unfavorable). . . 4,800
Direct Labor (at actual cost) . . . 46,480 To record the cost of direct labor charged to production.
*1,000 actual units 2 hours allowed per unit $20.00 per hour $40,000.
g.
Standard overhead costs allowed at 1,000 units of production:
Fixed overhead costs . . . $12,000
Variable overhead ($2 per unit 1,000 units) . . . 2,000 $14,000 Actual overhead costs incurred in March:
Fixed overhead costs . . . $12,850
Variable overhead . . . 2,352 15,202 Overhead spending variance (unfavorable) . . . $(1,202)
Overhead applied to work in process (1,000 units $12) . . . $12,000 Standard overhead allowed (at 1,000 units):
Fixed . . . $12,000 Variable ($2 per unit) . . . 2,000
Total overhead allowed at standard . . . 14,000 Overhead volume variance (unfavorable) . . . $(2,000) h.
Work in Process Inventory (at standard cost) . . . 12,000 Overhead Spending Variance (unfavorable) . . . 1,202 Overhead Volume Variance (unfavorable) . . . 2,000
Manufacturing Overhead (at actual cost) . . . 15,202 To apply overhead to production.
i.
Self-Test Questions Self-T est Questions
The answers to these questions appear on page 1074.
1. The labor rate variance is determined by multiplying the dif- ference between the actual labor rate and the standard labor rate by:
a. The standard labor hours allowed for a given level of output.
b. The standard labor rate.
c. The actual hours worked during the period.
d. The actual labor rate.
2. Which of the following is not a possible cause of an unfavor- able direct labor efficiency variance?
a. Lack of motivation.
b. Low-quality materials.
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c. Poor supervision.
d. All of the above could be considered possible causes of an unfavorable labor efficiency variance.
3. An unfavorable overhead volume variance indicates that:
a. Total fixed overhead has exceeded the standard amount budgeted.
b. Variable overhead per unit has exceeded the standard amount budgeted.
c. Actual production was less than the normal volume of output.
d. Actual production was more than the normal volume of output.
4. A favorable overhead spending variance means that:
a. Overhead has been overapplied.
b. Overhead has been underapplied.
c. Actual production was less than the normal volume of output.
d. None of the above.
5. Modern Art, Inc., produces handpainted foam mouse pads. The following budgeted and actual results are for a recent month in which actual production was equal to budgeted production.
Which of the following are true? (There may be more than one response.)
a. The materials price variance is favorable.
b. The direct labor rate variance is favorable.
c. The materials quantity variance is unfavorable.
d. The direct labor efficiency variance is unfavorable.
Budgeted Actual Amount Result Direct materials: Foam
Usage 1.5 square feet 1.3 square feet
per pad per pad
Price $0.15 per $0.18 per
square foot square foot Direct labor:
Usage .25 hours .30 hours
per pad per pad
Rate $15 per hour $13 per hour
1. Define standard costs and briefly indicate how they may be used by management in planning and control.
2. Identify what is wrong with the following statement: “There are three basic kinds of cost accounting systems: job order, process, and standard.”
3. Once standard costs are established, what conditions would require that standards be revised?
4. Identify the variances from standard cost that are generally computed for direct materials, direct labor, and manufactur- ing overhead.
5. Would a production manager be equally responsible for an unfavorable materials price variance and an unfavorable materials quantity variance? Explain.
6. What is meant by a favorable labor efficiency variance?
How is the labor efficiency variance computed?
7. Why is an unfavorable overhead volume variance usually not considered in evaluating the performance of the produc- tion department manager?
8. Why do overtime hours usually result in unfavorable direct labor rate variances?
9. How do direct materials variances and direct labor cost vari- ances differ from overhead cost variances?
10. At the end of the year, when closing the books, what is the treatment for immaterial standard variance account bal- ances? What is the treatment for standard variance account balances that are material in amount?
11. How can operating at 100 percent of capacity create unfa- vorable variances?
12. Why is it important to consider the relationships among cost, quality, and selling prices when establishing standards for direct materials?
13. Who might a plant accountant consult with when establish- ing direct labor quantity or rate standards?
14. Why are unfavorable variances recorded by using debit entries and favorable variances recorded by using credit entries?
15. Explain how efficiency and price or rate variances for direct labor can be closely interrelated.
Discussion Questions
ASSIGNMENT MATERIAL
Brief Exercises accounting
The production manager at Bramford Industries is investigating the cause of unfavorable materials and labor variances that occurred in the previous month. Standards are based on normal or expected production of 400 units per month at Bramford. The manager has discovered that 500 units were BRIEF
EXERCISE 24.1 Variances and Normal Capacity
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Brief Exercises 1057
needed the previous month to meet shipment needs as ordered by headquarters. During the previous month, 100 units were spoiled, so production last month was actually 600 units.
Use your judgment to speculate as to why the variances occurred at Bramford last month.
At Franklis Incorporated, during the month of January, the direct labor rate variance was $2,500 unfavorable, and the direct labor efficiency variance was $5,000 favorable. Actual direct labor costs during January were $87,000. What was the standard direct labor applied to production at Franklis during the month of January?
Use the information in Exhibit 24–5 on page 1046 to compute the expected volume variance at 750 units.
Jesse is the office manager of a large firm called Law & Legal Services, Inc. At Law & Legal Services, overhead is allocated to client accounts using hours billed. Jesse found the following information related to overhead for the previous month:
• Spending variance $14,000 unfavorable • Volume variance $6,000 favorable • Actual overhead $56,000
• Actual hours billed 4,000 hours
Are the normal or expected hours for billing each month higher or lower than the actual hours billed last month? Were the actual expenditures of office supplies, equipment, indirect labor, and so on, higher or lower than expected?
BRIEF
EXERCISE 24.2 Standard Cost Applied to Production B
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BRIEF
EXERCISE 24.3 Expected Volume Variance
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BRIEF
EXERCISE 24.4 Volume and Spending Variances
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BRIEF
EXERCISE 24.5 Normal versus Ideal Standard Costs B
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Normal or Expected
Standards Ideal Standards
Direct materials quantity per unit . . . 2 lbs. per unit 1.8 lbs. per unit Direct materials price per pound . . . $8 per lb. $7.75 per lb.
Direct labor hours per unit . . . 3 hours per unit 2.8 hours per unit Direct labor rate per hour . . . $22 per hour $21.50 per hour
Compute the standard cost per finished unit for the normal or expected standards and for the ideal standards. Explain how both normal and ideal standards would be used by managers.
A popular product of Loring Glassworks is a hand-decorated vase. The company’s standard cost system calls for 0.75 hours of direct labor per vase, at a standard wage rate of $8.25. During September, Loring produced 4,000 vases at an actual direct labor cost of $24,464 for 2,780 direct labor hours.
What is the actual wage rate per hour? Compute the labor rate and efficiency variances for the month. Was paying workers the actual wage rather than the standard wage an efficient strategy for Loring?
See Brief Exercise 24.6. Provide the journal entry for direct labor usage for the month of September for Loring Glassworks.
BRIEF
EXERCISE 24.6 Computing Labor Cost Variances B
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BRIEF
EXERCISE 24.7 Journal Entry for Direct Labor B
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