Fundamentals of

Variance Analysis

Chapter Sixteen LEARNING OBJECTIVES

LO 16-1 Use budgets for performance evaluation.

LO 16-2 Develop and use flexible budgets.

LO 16-3 Compute and interpret the sales activity variance.

LO 16-4 Prepare and use a profit variance analysis.

LO 16-5 Compute and use variable cost variances.

LO 16-6 Compute and use fixed cost variances.

LO 16-7 (Appendix) Understand how to record costs in a standard costing

system.

Jaak Nilson/Spaces Images/

Blend Images LLC
 & & For the second month in a row, profits at our Peak costs—and report back to me next week. If Peak can’t
Division are down and | don’t know why. We bud- improve, we may have to dispose of jt.3 ¥
geted $190,000 in profit for August, but the actual
Keith Hunter, the CFO of Brunswick, Inc., was discussing
result was only $114,500. We thought we had devel-
his concern about the performance of the company’s Peak
oped realistic monthly budgets. | know sales were
Division. Brunswick purchased Peak just over one year ago in
down some, but I'm not sure that is the only problem
hopes of building some synergies between Brunswick’s spe-
there is.
cialty supplements and Peak’s sole product, an energy drink
What | need to know is whether we should focus on
popular with students and young adults. The Peak Division
improving the marketing of the division or if we need
operates as a profit center. The synergies have been slow to
to take a look at our production activities there. | have
develop. In addition, Peak’s profit performance has been dis-
asked Claudia [Ramos, the president of Peak] to iden-
appointing and Peak’s management has been under consid-
tify the primary cause of the shortfall—revenues or
erable pressure to show improvement.

Using Budgets for Performance Evaluation

In Chapter 13, we described the development of the master budget as a first step in
LO 16-1
the budgetary planning and control cycle. The budgeting process provides a means to
Use budgets for
coordinate activities among units of the organization, to communicate the organiza-
performance evaluation.
. tion’s goals to individual units, and to ensure that adequate resources are available
c to carry out the planned activities. Typically, the budget is set prior to the beginning
of the accounting period, although it is common for budgets to be revised during the
accounting period as major changes in operations are encountered (e.g., large changes
in expected sales).
While this planning aspect of budgets is important, it is not the only role that bud-
gets can play. In the control and evaluation activity, the performance of units and man-
agers is evaluated and actions are taken in an attempt to improve performance. As we
discussed in Chapter 14, evaluation requires a benchmark against which to measure
performance. When evaluating a firm’s performance, it is common to select other firms
in the same industry as benchmarks. Financial performance, as reported in publicly
available accounting records, is one measure of performance. For units of the firm or
for organizations that don’t routinely prepare public reports (for example, government
organizations and not-for-profit firms), these benchmarks are much more difficult to
collect. One obvious alternative is the budget; this is management’s plan for financial
performance.
The master budget includes operating budgets (for example, the budgeted income operating budgets
statement, the production budget, the budgeted cost of goods sold) and financial budgets Budgeted income statement,
(for example, the cash budget, the budgeted balance sheet). When management uses the S;Z?g?'i’;g:igle;' s;’sgeted
master budget for control purposes, it focuses on the key items that must be controlled to SKibp On?ng blsdg iy

ensure the company’s success. Most of these items are in the operating budgets, although
financial budgets
some also appear in the financial budgets. In this chapter, we focus on the income state- Budidets offinancial
ment l?ecause it is the most important financial statement that managers use to control (/e tor example, the
operations. cash budget and the budgeted
When actual results are compared to budgeted, or planned, results, there is almost balance sheet.
always a difference, or variance. Variance analysis uses the difference between actual variance
performance and budgeted performance to Difference between planned
result and actual outcome.
1. Evaluate the performance of individuals and business units.
2. Identify possible sources of deviations between budgeted and actual performance.

731
732 Part IV Management Control Systems

As with all management accounting practices, firms and organizations may develop
many variances for their own needs. The basic idea, however, is always the same:
1. . Calculate the difference between actual performance and a planned (budgeted) number.
2. Attempt to explain the causes of the difference.

Profit Variance
The simplest measure of performance is the variance, or difference, between actual income
and budgeted income. Peak’s profit variance, for example, is $75,500. That is the actual
profit of $114,500 less the budgeted profit of $190,000. Because actual income was less
than budgeted income, this is typically referred to as an unfavorable variance. For evalu-
ation purposes, we could stop here and say that Peak’s performance did not meet expecta-
tions because actual income was less than budgeted. However, this does not provide much
information about the causes of its actual performance. We want to look more closely at
the information available and try to use it to obtain more insight into operations.
See Exhibit 16.1 for Peak Division’s actual income statement and the master budget
for August. The master budget represents the financial plan for Peak for the month, and
the actual results reflect the performance.
Before we analyze the variances in more detail, it is important to understand what the
labels “favorable” and “unfavorable” mean. Traditionally, they are used to indicate how
actual income differs from budgeted income. That is,

favorable variance * A favorable variance increases operating profits.

Variance that, taken alone,
* An unfavorable variance decreases operating profits.
results in an addition to
operating profit. Thus, when discussing revenue, income, or contribution margin, a favorable vari-
unfavorable variance ance means the actual result is greater than the budgeted result. When discussing costs,
Variance that, taken alone, a favorable variance indicates that actual costs are less than budgeted costs. The labels
reduces operating profit. “favorable” and “unfavorable” should not be considered as indications of good or bad
performance without additional investigation:
¢ A favorable variance is not necessarily good.
¢ An unfavorable variance is not necessarily bad.

Exhibit 16.1 ‘ A 5 B C D |

; § S | Actual Master Budget

Budget and Actual
2 | Sales (units) 80,000 100,000
Results, August—Peak
Division $ 840,000 $ 11000,000} bl iy
4 | Sales revenue
5 |Less
6 | Variable costs
7 | Variable manufacturing costs i 329,680 380,0005 1
'8 | Variable selling and administrative 68,000 _90,000°
9 | Total variable costs $ 397,680 $ 470,000
10 | Contribution margin $ 442,320 $ 530,000
11 | Fixed costs
12| Fixed manufarcturing overhead 195,500 200,000
13| Fixed selling and administrative costs 132,320 140,000
14 | Total fixed costs $ 327,820 $ 340,000
15 | Profit $ 114,500 $ 190,000

17 | Calculation for master budget:

18 | 2100,000 units at $ 10.00 per unit.
19 | 2100,000 units at $ 3.80 per unit.
| 20 | ©100,000 units at $ 0.90 per unit.
21
 Chapter 16 Fundamentals of Variance Analysis

When a Favorable Variance Might Not Mean “Good” News

Although it is common to consider favorable variances as The profits of one insurer, UnitedHealth Group, doubled in one
good news, we should recognize that any variance repre- quarter. The reason?
sents a difference from what we expected (the budget or
... [E]lective procedures the large health insurer pays
standard). When a unit or a firm reports higher-than-expected
for were postponed or delayed amid the spread of the
profits, it is important to understand why. It might be that
Coronavirus strain Covid-19.
the managers found more efficient ways to operate or a
marketing campaign was more successful than expected. In this case, executives at UnitedHealth Group recognized that
If so, it would be important to share this with other units. It this profit windfall did not indicate future good news.
could also be that managers have found ways to manipu-
... UnitedHealth Group didn’t raise its earnings expecta-
late operations or reported financial results to make perfor- tions or change its 2020 financial guidance as the health
mance look better than it really is. It is not uncommon when insurer braced for patients to seek care later this year and
accounting fraud cases come to light that supervisors were into 2021 that might even be more costly than anticipated.
surprised given the “favorable” results that the guilty manag-
ers had generated.
Source: Japsen, Bruce, “UnitedHealth Group Doubles Profits as Patients
Another possibility is that the favorable results this period
Defer Care in Pandemic,” [Link], July 15, 2020. [Link]
point to future events that will depress profits. One example is [Link]/sites/brucejapsen/2020/07/15/unitedhealth-group-profits
the health insurance industry during the COVID-19 pandemic. -double-as-patients-defer-treatment-in-pandemic/?sh=53b99087506c.

Although the fact that profit is $75,500 below budget provides some information, it
does not indicate where the managers at Peak should look for improvement. At a more
detailed level, we can compute the variance of each income statement line item (see Exhibit
16.2). Notice that the data in the Variance column of Exhibit 16.2 provides information
useful for understanding the source of the difference between planned and realized profit
performance. Although a simple comparison of planned and actual profit suggests that
performance was worse than planned, the additional data in Exhibit 16.2 provide informa-
tion on the impact on profit performance of each of the revenue and cost categories.
This information can be useful for two reasons. First, it allows the manager to inves-
tigate more efficiently the causes of off-budget performance. That is, the manager can
analyze those areas with a relatively large variance and, if the investigation identifies the

A B (& D E Exhibit 16.2

1 Actual Variance Master Budget |
Budget and Actual
2 | Sales (units) 80,000 20,000 | U 100,000
Results, August—Peak
3 - Division
4 | Sales revenue $ 840,000, $160,000 U $ 1,000,000 |
5 |Less
6 Variable costs
4 Variable manufacturing costs 329,680 50,320 F 380,000
8 Variable selling and administrative 68,000 22,000 | F 90,000 |
9 Total variable costs $397,680| $ 72,320| F $ 470,000
10 | Contribution margin $442320 $ 87,680 | U $ 530,000
11 | Fixed costs |
12 Fixed mahufacturing overhead 195,500 4,500 | F 200,000
13 Fixed selling and administrative cbsts 132,320 7,680 | F 140,000
14 | Total fixed costs $327.8201 3 12,180 | F $ 340,000
15 | Profit $114,500 $ 75,500 | U $ 190,000
16
17 U= Unfavorable variance.
18 | F = Favorable variance.
19
734 Part IV Management Control Systems

problem and it can be corrected, the organization will be more likely to improve its per-
formance in the following period. Second, the information allows the manager to evalu-
ate subordinate managers responsible for various aspects of the firm’s operations (for
example, marketing and production).

Why Are Actual and Budgeted Results Different?

The decomposition of the profit variance into revenue and cost components is more infor-
mative than the simple profit variance itself, but it does not give information that would be
useful for control purposes. Managers at Peak want to know how they should change its
marketing or production operations to improve results. In other words, managers want to
know why the individual line items in Exhibit 16.2 differ. An important part of variance
analysis is understanding, first, what might cause a difference between actual and budgeted
results and, second, what portion of the total profit variance is due to each cause.

Flexible Budgeting
One obvious reason that actual results might differ from budgeted results is that the
LO 16-2
actual activity itself sometimes differs from the budgeted or expected activity. A master
Develop and use
budget presents a comprehensive view of anticipated operations. Such a budget is typi-
flexible budgets.
cally a static budget; that is, it is developed in detail for one level of anticipated activity.
A flexible budget, in contrast, indicates budgeted revenues, costs, and profits for virtu-
static budget ally all feasible levels of activities. Because variable costs and revenues change with
Budget for a single activity
level; usually the master
changes in activity levels, these amounts are budgeted to be different at each activity
budget. level in the flexible budget.
For example, by reviewing the master budget information in Exhibits 16.1 and 16.2,
flexible budget
Budget that indicates we see that the total cost of producing and selling 100,000 units (cases) of the energy
revenues, costs, and profits for drink at Peak is $810,000. This consists of $470,000 in variable costs and $340,000 in
different levels of activity. fixed costs. In developing the budget, Peak used the following budgeting formula to
determine costs at the master budget level:
Total cost = $340,000 + ($4.70 x Units produced and sold)
Total variable costs are $470,000 for 100,000 units, or $4.70 per unit. See Exhibit 16.3
for a graph of this cost function. This is the same type of cost line used for the cost-
volume-profit (CVP) analysis that we described in Chapter 3. The expected activity level
flexible budget line for the period is budgeted at 100,000 units. From the flexible budget line in Exhibit 16.3, we
Expected monthly costs at find the budgeted costs at a planned activity of 100,000 units to be $810,000 [= $340,000
different output levels.
+ ($4.70 x 100,000 units)].
At first glance, it might appear that the division had done a good job of cost con-
trol because actual costs were $84,500 lower than the budget plan (variable costs were
$72,320 lower and fixed costs were $12,180 lower). In fact, Peak actually produced and
sold only 80,000 units. According to the flexible budget concept, the master budget must
be adjusted for this change in activity. The adjusted budgeted costs for control and per-
formance evaluation purposes would be the flexible budget for actual activity, $716,000
[= $340,000 + ($4.70 x 80,000 units)], which is /ess than the actual costs.
The estimated cost-volume line in Exhibit 16.3 is known as the flexible budget line
because it shows the budgeted costs allowed for each level of activity. For example, if
activity increased to 120,000 units, budgeted costs would be $904,000 [= $340,000 +
($4.70 x 120,000 units)]. If activity dropped to 50,000 units, budgeted costs would drop
to $575,000 [= $340,000 + ($4.70 x 50,000 units)].
You can compare the master budget with the flexible budget by thinking of the mas-
ter budget as an ex-ante (before-the-fact) prediction of the activity (X); the flexible bud-
get is based on ex-post (after-the-fact) knowledge of the actual activity.
 Chapter 16 Fundamentals of Variance Analysis 735

Exhibit 16.3 Flexible Budget Line Costs—Peak Division

$
Costs

Master budget
total costs
=$ 810,000

Actual costs
=$ 725,500

Flexible budget
total costs
=$ 716,000

Fixed costs
= $ 340,000

Flexible budget Master budget Units sold

activity level activity level
= 80,000 units = 100,000 units

Comparing Budgets and Results

A comparison of the master budget with the flexible budget and with actual results is LO 16-3
the basis for analyzing differences between plans and actual performance. The flexible
Compute and interpret
budget (see Exhibit 16.4) is based on actual activity. In August, Peak actually produced
the sales activity
and sold 80,000 units. We start by understanding the difference in operating profits that
variance.
results from the sales activity at Peak.

Sales Activity Variance

The difference between operating profits in the master budget and operating profits in the
flexible budget is called a sales activity variance. The $106,000 unfavorable variance sales activity variance
is due to the activity that resulted in a 20,000-unit difference between actual sales and Difference between operating
profit in the master budget and
planned sales. operating profit in the flexible
The information in Exhibit 16.4 is useful for management. First, it isolates the budget that arises because the
decrease in operating profits caused by the decrease in activity from the master budget. actual number of units sold is
Furthermore, the resulting flexible budget shows budgeted sales, costs, and operating different from the budgeted
profits after considering the activity decrease but before considering differences in unit number; also known as sales
volume variance.
selling prices, variable costs, and fixed costs from the master budget. As noted, we refer
to this change from the master budget plan as the sales activity variance, also known as
sales volume variance.
736 Part IV Management Control Systems

Exhibit 16.4 A [ B c D E J

Budget, August—Peak actual activity | (basedon | planned

Division of 80,000 variance in activity of
1 units) | sales volume) 100,000 units)

|2| Sales units ; 180,000 20000 | 100,000

3
4 | Sales revenue $ 800,000 $ 200,000 | U $ 1,000,000
5 | Less
6 Variable costs 3 s i
7 | Variable manufacturing costs 304,000 76,000|F 380,000
8| Variable selling and administrative 72,000 18,000 F 90,000
9 | Total variable costs $ 376,000 $ 94,000 | F $ 470,000
10 | Contribution margin $424,000 $106,000 U $ 530,000
11 Fixed costs
12 Fixed manufacturing overhead 200,000 -0- 200,000
13 Fixed selling and administrative costs 140,000 -0-— 1»40,000
14 Total fixed costs : $ 340,000 -0-| $ 340,000
15 Profit $ 84000 $106000 U $ 190,000
16

Note the makeup of the $106,000 sales activity variance in Exhibit

16.4. First, the difference between the master budget sales of $1,000,000
and the flexible budget sales of $800,000, which is the budgeted $10 unit
sales price multiplied by the 80,000 units actually sold, is $200,000. This
is based on the 20,000-unit decrease in sales volume multiplied by the ‘)
budgeted $10 unit sales price. We use the budgeted unit sales price instead
of the actual price because we want to isolate the impact of the activity
decrease from changes in the sales price. We want to focus on the effects
of volume alone. Thus, the sales amount in the flexible budget is not the
actual revenue (actual price times actual volume) but the budgeted unit
sales price times the actual number of units sold. Second, variable costs
Whéh kales fall aind plafts radsice are expected to decrease by $94,000, giving an unfavorable contribution
production, manufacturing costs decrease. margin of $106,000 (= $200,000 — $94,000), which is the unfavorable
Companies compute a sales activity variance sales activity variance.
to distinguish between lower sales and
increased manufacturing efficiency as 3 :
explanations for the lower reported costs. Interpreting Variances Holding everything else constant, the
Steve Allen/Brand X Pictures/Getty Images 20,000-unit decrease in sales creates an unfavorable sales activity variance
as shown in Exhibit 16.4. Does this indicate poor performance? Perhaps
it does not. Economic conditions could have been worse than planned,
decreasing the volume demanded by the market. Hence, perhaps, the 20,000-unit decrease
in sales volume could have been even greater, taking everything into account.
Note that both variable cost variances are labeled favorable, but this doesn’t mean
that they are good for the company. Variable costs are expected to decrease when volume
is lower than planned.

Self-Study Question

1. Prepare a flexible budget for Peak Division for August with The solution to this question is at the end of the chapter. )
the same master budget as in Exhibit 16.4 but assuming
that 110,000 units were actually sold.
 Chapter 16 Fundamentals of Variance Analysis 737

Profit Variance Analysis as a Key Tool for Managers

The profit variance analysis shows additional detail about the differences between bud-
LO 16-4
geted profits and actual profits earned. The actual results can be compared with both
the flexible budget and the master budget in a profit variance analysis (Exhibit 16.5). Prepare and use a profit

Columns (5), (6), and (7) are carried forward from Exhibit 16.4. variance analysis.
Column (1) is the reported income statement based on the actual sales (see Exhibit 16.1).
Column (2) summarizes manufacturing (production) variances, which are discussed in profit variance analysis
more detail later in this chapter, and Column (3) shows marketing and administrative vari- Analysis of the causes of
differences between budgeted
ances. Costs have been divided into fixed and variable portions here and would be presented
profits and the actual profits
in more detail to the managers of centers having responsibility for them. earned.
Cost variances result from deviations in input prices and efficiencies in operating the
company. They are important for measuring productivity and helping to control costs.

Sales Price Variance

The sales price variance, Column (4) in Exhibit 16.5, is derived from the difference sales price variance
between the actual revenue and budgeted selling price multiplied by the actual number of Difference between actual
units sold [$40,000 = ($840,000 — {$10 x 80,000 units})]. This is equivalent, of course, to revenue and actual units sold
multiplied by budgeted selling
the difference between the average actual selling price ($10.50 = $840,000 + 80,000 units) price.
and the budgeted selling price ($10) multiplied by the actual quantity sold [= $40,000 =
($10.50 — $10) x 80,000 units].

Variable Production Cost Variances

Be careful to distinguish the variable cost variances in Columns (2) and (3) of Exhibit 16.5,
which are input variances, from the variable cost variances in Column (6), which are part
of the sales activity variance. Management expects the costs in the flexible budget to be
lower than the master budget, creating a sales activity variance, because the sales volume
is lower than planned.
As indicated in Column (5), variable production costs should have been $304,000 for
a production and sales volume of 80,000 units, not $380,000 as expressed in the master
budget in Column (7). Column (1) indicates that the actual variable production costs
were $329,680, or $50,320 (= $76,000 F — $25,680 U) lower than the master budget,
but $25,680 higher than the flexible budget. Which number should be used to evaluate
production cost control, the $50,320 F variance from the master budget or the $25,680 U
variance from the flexible budget?
The number to use to evaluate production performance is the $25,680 U variance
from the flexible budget. This points out a benefit of flexible budgeting. A superficial
comparison of the master budget plan with the actual results would have indicated a
favorable variance of $50,320. In fact, production is actually responsible for an unfavor-
able variance of $25,680, which is caused by deviation from production norms. We dis-
cuss the source of this $25,680 in more detail in the following section.

Fixed Production Cost Variance

The fixed production cost variance is simply the difference between actual and budgeted
costs. Fixed costs are treated as period costs here; they should not be affected by activity
levels within a relevant range. Hence, the flexible budget’s fixed costs equal the master
budget’s fixed costs.

Marketing and Administrative Variances

Marketing and administrative costs are treated like production costs. Variable costs are
expected to change as activity changes; hence, variable costs were expected to decrease
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 Chapter 16 Fundamentals of Variance Analysis 739

by $18,000 between the flexible and master budgets (Exhibit 16.5) because volume
decreased by 20,000 units. The $4,000 favorable variance for variable marketing and
administrative costs must be caused by factors other than sales activity. Comparing actual
costs with the flexible budget reveals a $7,680 favorable variance for fixed marketing and
administrative costs. Fixed marketing and administrative costs do not change as volume
changes; hence, the flexible and master budget amounts are the same.

Visualizing Profit Variances

Recall that Keith Hunter, the CEO of Brunswick, Inc., wanted to understand the role
of revenues versus costs in explaining the disappointing financial results. The variance
analysis we just completed will allow Claudia Ramos, the president of Peak Division,
to answer this question. Rather than just presenting the results in Exhibit 16.5, however,
she decides to prepare the information in visual form to highlight the key findings. Her
visualization is shown in Exhibit 16.6, which shows the relative effect of sales versus
operating costs on Division profits.
Although the information in Exhibit 16.6 answers the question about sales versus
costs in the impact on profit, it is not particularly informative. A fuller picture is pos-
sible using the information in Exhibit 16.5. Exhibit 16.7 breaks down the sales and cost
information into components to help managers focus attention on areas that might be
worthwhile looking at to improve results.
As we see in Exhibit 16.7, the largest variances are sales and variable manufacturing
costs. For sales, this includes both the sales activity variance, which is unfavorable, and sales
price variance, which is favorable. By comparison, the other variances (fixed manufactur-
ing costs, and marketing and administration costs) are small (and favorable). In Chapter 17,
we consider the sales activity variance in more detail to determine whether the unfavorable
variance is due to a decline in activity in the industry or to a reduced market share (or both).
A general decline in industrial volume is generally more difficult for the firm to overcome.
One last possibility is that with a favorable price variance, it might be that the higher price
led to sales declines sufficiently large that the overall effect was to reduce profits.

Exhibit 16.6 Visualization of Variances Results for Peak Division

Brunswick, Inc.
Peak Division
Variance Analysis: Sales versus Costs
(Note: Negative Variances Resulted in Lower Profits)

($70,000) ($60,000) ($50,000) ($40,000) ($30,000) ($20,000) ($10,000) $0

Sales
740 Part IV Management Control Systems

Exhibit 16.7 Visualization of Variances Results for Peak Division: Variances by Profit Category

Brunswick, Inc.
Peak Division
Variance Analysis: By Major Profit Category
(Note: Negative Variances Resulted in Lower Profits)
($120,000) ($100,000) ($80,000) ($60,000) ($40,000) ($20,000) $0 $20,000 $40,000 $60,000

Sales activity

Sales price

Variable ring costs

Fixed manufacturing costs

Variable marketing administration costs

Fixed marketing and administration costs

I I I I

In the next section, we consider the manufacturing cost variances in more detail in
a way that provides managers information they can use to identify and possible areas for
improvement.

Performance Measurement and Control in a Cost Center

Before this point, we have considered the measurement of variances for the evaluation
and control of profit centers. The performance measure was profit and the variances were
computed as differences between various components of profits. To investigate the cost
variances further, we now change the focus of the analysis to a cost center level and con-
sider using costs (budgeted, or planned, versus actual) as a basis for performance evalu-
ation. Because we are focusing on cost centers whose production managers typically do
not control what they are asked to produce, we will use actual unit production, not sales,
as a baseline. We begin with the costs associated with the flexible budget and analyze
differences between actual costs and these flexible budget costs.

Variable Production Costs

We start the analysis with the budgeting information used to determine variable product
costs, namely the quantities of inputs and the input unit prices. For any variable resource
(e.g., direct materials), the unit variable cost in the budget is determined by multiply-
ing the expected (budgeted) amount of the resource used in each unit of output by the
standard cost sheet expected price of each unit of the resource.
Form providing standard See Exhibit 16.8 for the basic data for the analysis of Peak’s production cost vari-
quantities of inputs used to
ances in the standard cost sheet. This standard cost sheet provides the quantities of each
produce a unit of output and
the standard prices for the input required to produce a unit of output along with the budgeted unit prices for each
inputs. input. Notice that overhead “quantity” is expressed in terms of direct labor-hours because
 Chapter 16 Fundamentals of Variance Analysis 741

() (1) @ e Exhibit 16.8

Standard Standard Standard Standard Cost Sheet,
Quantity of Input Price or Cost per Unit| Variable Manufacturing
Input per Unit Rate per Unit of Output Costs, August—Peak
Input of Output of Input (Case) Division
Birtectmateridl il s ol . 0w 50 4 pounds $ 0.55 per pound $2.20
Pirectlabor. o o o co00 - 0 0.05 hour 20.00 per hour 1.00
Vahableoverhead: 0 twi 0.0 0.05 hour 12.00 per hour 0.60
Total variable manufacturing costs. . . $3.80

that is what is being used to apply the overhead. Thus, the standard cost per unit of input
for overhead is really the standard labor-based burden rate.

Direct Materials Peak determines the standard price of the materials it uses to make
the drink as follows. For simplicity we assume that a single material (powder) is used
and each unit of drink requires 4 pounds of this powder. Peak’s purchasing manager esti-
mates that the cost of powder with the correct specifications and quality should be $0.55
per pound. The $0.55 is the standard price for a unit of input, not output. The standard
materials cost for a unit of output, a case of the drink, is $2.20 (= 4 pounds x $0.55 per
pound).

Direct Labor Direct labor standards are based on a standard labor rate for the work
performed and the standard number of labor-hours required. The standard labor rate
includes wages earned as well as fringe benefits, such as medical insurance and pension
‘ plan contributions, and employer-paid taxes (for example, unemployment taxes and the
employer’s share of an employee’s Social Security taxes). Most companies develop one
standard for each labor category.
We assume that Peak Division has only one category of labor. The standard labor
cost for each good unit of the drink completed is $1 (= 0.05 hour x $20 per hour).

Variable Production Overhead We discussed in Chapters 6 and 7 the way that

companies determine an activity measure to apply production overhead. Peak uses a sim-
ple variable overhead basis, direct labor-hours, to determine its variable overhead stan-
dards. Management reviewed prior-period activities and costs, estimated how costs will
change in the future, and performed a regression analysis in which overhead cost was the
dependent variable and labor-hours the independent variable. After analyzing these esti-
mates, the accountants determined that the best estimate was $12 per standard labor-hour
as the variable production overhead rate. The standard variable overhead cost for each
good unit of drink completed is $0.60 (= 0.05 hour X $12 per hour).

Variable Cost Variance Analysis

Standard costs are used to evaluate a company’s performance. Comparing the budget
LO 16-5
(prepared using standard costs) to actual results identifies production cost variances. We
Compute and use
now review production cost variances in detail.
variable cost variances.

cost variance analysis

General Model Comparison of actual input
‘ i i X B : amounts and prices with
The conceptual cost variance analysis model compares actual input quantities and prices siandard input amounts and
with standard input quantities and prices. Both the actual and standard input quantities prices.
742 Part IV Management Control Systems

Exhibit 16.9
General Model for ) (2) 3)
Actual Inputs at Flexible Production
Variable Cost Variance Budget
Actual Standard Prices
Analysis

Actual input price (AP) Standard input price (SP) Standard input price (SP)
times actual quantity times actual quantity times standard quantity
(AQ) of input (AQ) of input (SQ) of input allowed for
actual good output

(AP x AQ) (SP x AQ) (SP x SQ)

Efficiency variance?
2 -B3)

2 The terms price and efficiency variances are general categories. Terminology varies from company to
company, but the following specific variance titles are frequently used:

Input Price Variance Category Efficiency Category

Direct materials Price (or purchase price) variance Usage or quantity variance

Direct labor Rate variance Efficiency variance

Variable overhead Spending variance Efficiency variance

We shall avoid unnecessary complications by simply referring to these variances as either a price or
efficiency variance.

price variance are for the actual output attained. A price variance and an efficiency variance can
Difference between actual be computed for each variable manufacturing input (see Exhibit 16.9). The actual costs
costs and budgeted costs
incurred—Column (1)—for the time period are compared with the standard allowed per
arising from changes in the
cost of inputs to a production unit times the number of good units of output produced—Column (3). This comparison
process or other activity. provides the total cost variance for the cost or input.
Some companies compute only the total variance. Others make a more detailed
efficiency variance
Difference between budgeted breakdown into price and efficiency variances. Managers who are responsible for price
and actual results arising from variances would not be held responsible for efficiency variances and vice versa. For
differences between the inputs example, purchasing department managers are usually held responsible for direct materi-
that were budgeted per unit of
als price variances, and manufacturing department managers are usually held responsible
output and the inputs actually
for using the direct materials efficiently.
used.
This breakdown of the total variance into price and efficiency components is facili-
total cost variance tated by the middle term, Column (2), in Exhibit 16.9. In going from Column (1) to
Difference between budgeted
and actual results (equal to the Column (2), we go from actual price (AP) times actual quantity (AQ) of input to stan-
sum of the price and efficiency dard price (SP) times actual quantity (AQ) of input. Thus, the variance is calculated as
variances).
Price variance = (AP X AQ) — (SP X AQ)
= (AP — SP) X AQ

The efficiency variance is derived by comparing Column (2), standard price (SP)
multiplied by actual quantity of input (AQ), with Column (3), standard price (SP) multi-
plied by standard quantity of input allowed for actual good output produced (SQ). Thus,
the efficiency variance is calculated as

Efficiency variance = (SP X AQ) — (SP X SQ)

= SP X (AQ — SQ)
 Chapter 16 Fundamentals of Variance Analysis 743

This general model could seem rather abstract at this point, but as we work examples,
it will become more concrete and intuitive to you.
As the general model outlined in Exhibit 16.9 is applied to each variable cost
incurred, a more comprehensive cost variance analysis results. The general model of the
comprehensive cost variance analysis will be applied to Peak Division’s variable produc-
tion costs. The comprehensive cost variance analysis will ultimately explain, in detail, the
unfavorable variable production variance of $25,680 that we calculated in Column (2) of
Exhibit 16.5.
As we proceed through the variance analysis for each production cost input—
direct materials, direct labor, and variable production overhead—you will notice some
minor modifications to the general model presented in Exhibit 16.9. It is important to
recognize that these are modifications to one general approach rather than a number of
independent approaches to variance analysis. In variance analysis, a few basic meth-
ods can be applied with minor modifications to numerous business and nonbusiness
situations.

Direct Materials
Information about Peak Division’s use of direct materials for August follows:

Standard costs %
4 pounds per case @ $0.55 perpound ............ =$2.20 percase |
Cases broducetim Auglist = il o F e oo n = 80,000
Actual materials purchased and used i
328,000 pounds @ $0.60 perpound.............. =$196,800

These relationships are shown graphically as follows:

Actual cost
APROY$100.800 Femmmmntil L Sl il .
Materials price variance $16,400 U E
(SPxAQ) $180,400 [ -===============mmmee !
1

Materials efficiency variance $4,400 U |

1
1

(SPXSQ) $176,000 f--============mmm e '

Standard cost !
I

&
o 5'
6‘336 |
o :
:
1
1
1

s
80,000

Number of cases produced

744 Part IV Management Control Systems

An alternative way to view these variances graphically follows. Material quantities

are shown on the horizontal axis and the prices for the materials are shown on the verti-
cal axis. The area of the outside box is $196,800 (= $0.60 x 328,000 pounds), the actual
price multiplied by the actual quantity of material.
The area of the box on the lower left-hand side is the standard or budgeted cost of
the materials for the actual quantity of output produced, $176,000 (= $0.55 x 320,000
pounds). The areas of the other two boxes are the price and efficiency variances.

AP
= $0.60 per
pound

SP
= $0.55 per
pound

SQ AQ
=4 x 80,000 = 328,000
= 320,000 pounds pounds

Actual cost = $176,000 + $16,400 + $4,400 = $196,800

Based on these data, the direct materials price and efficiency

variance calculations are shown in Exhibit 16.10. Note that with a
standard of 4 pounds per case and 80,000 cases actually produced in
August, Peak expects to use 320,000 pounds to produce the 80,000
cases. Because each pound of material has a standard cost of $0.55,
the standard materials cost allowed to make 80,000 cases is
Standard cost allowed to produce 80,000 cases = SP X SO
= $0.55 X (4 pounds x 80,000 cases)
= $176,000
Note that Column (3) of Exhibit 16.10 is called the flexible
production budget. The flexible budget concept can be applied to
For a maker of wooden products, an unfavorable material production as well as to sales. The flexible budget in Exhibit 16.5
efficiency variance can be a signal of increased scrap that a5 based on actual sales volume (that is, number of cases sold).
results from an inefficient production process. A wood
cutting station with saws that have dull blades could be The flexible budget in Exhibit 16.10 is based on actual production
the cause. James Hardy/PhotoAlto volume (that is, number of cases produced).!
flexible production budget
Standard input price times Responsibility for Direct Materials Variances The direct materials price
standard quantity of input variance (see Exhibit 16.10) shows that in August, the prices paid for direct materi-
allowed for actual good output. als exceeded the standards allowed, thus creating an unfavorable variance of $16,400.
Responsibility for this variance is usually assigned to the purchasing department. Reports

!'In this case, the number of units sold is equal to the number of units produced. We discuss situations in
which production and sales differ in Chapter 17.
 Chapter 16 Fundamentals of Variance Analysis 745

Exhibit 16.10 Direct Materials Variances, August (80,000 Cases)—Peak Division

(1) () 3)
Actual Inputs at Flexible Production
Actual Standard Price Budget
Actual materials price Standard materials price Standard materials price
(AP = $0.60) (SP = $0.55) (SP = $0.55)
X Actual quantity X Actual quantity X Standard quantity
(AQ = 328,000 pounds) (AQ = 328,000 pounds) (SQ = 320,000 pounds)
of direct materials of direct materials of direct materials
allowed for actual output
(AP x AQ) (SP x AQ) (SP x SQ)
$0.60 x 328,000 : $0.55 x 328,000 $0.55 x 320,000
= $196,800 = $180,400 : =$176,000
Price variance? Efficiency variance?
$196,800 — $180,400 $180,400 — $176,000
= $16,400 U = $4,400 U

2 Shortcut formulas: (AP x AQ)— (SP x AQ) (SP x AQ) — (SP x SQ)
= (AP - SP) x AQ =SP x (AQ - SQ)
= ($.60 — $.55) x 328,000 = $.55 x (328,000 — 320,000)
=$16,400 U =$4,400 U

T Total variance T

=$20,800 U

to management include an explanation of the variance, for example, failure to take pur-
chase discounts, higher transportation costs than expected, different grade of direct mate-
rials purchased, or changes in the market price of direct materials.
The explanation for Peak’s variance was the closure of a nearby vendor’s plant,
which required a change in suppliers and increased transportation costs that caused the
price of materials to be higher than expected. The long-term effect on prices is uncertain,
so management has begun market research to determine whether Peak should attempt to
increase sales prices for its drink.
Direct materials efficiency variances are typically the responsibility of production
departments. In setting standards, an allowance is usually made for defects in direct mate-
rials, inexperienced workers, poor supervision, and the like. If actual materials usage
is less than these standards, a favorable variance occurs. If usage exceeds standards, an
unfavorable variance occurs.
At Peak, the unfavorable materials efficiency variance was attributed to an increase
in the amount of scrap that results from the blending process. One of the new employees
hired in August required some time to learn to work efficiently with the powder. The pro-
duction supervisor claimed that this was a one-time occurrence and anticipated no similar
problems in the future.

Direct Labor
To illustrate the computations of direct labor variances, assume the following for Peak
Division:
~
Standard costs: 0.05 hour per case @ $20 perhour=........ $1 per case "

Number of cases produced in August. ...................... 80,000

Actual direct labor costs
ACHIANNOTESWATKEt: . . e T 4,400
fotal aciiallaharcostiiivy s i s o Sl Beil i W $79,200
Average cost per hour (= $79,200 + 4,400 hours) ......... $18
746 Part IV Management Control Systems

Exhibit 16.11 Direct Labor Variances, August (80,000 Cases)—Peak Division

(1) (2) (3)

Actual Inputs at Flexible Production
Actual Standard Price Budget

Actual labor price Standard labor price Standard labor price

(AP =$18) (SP = $20) (SP = $20)
x Actual quantity X Actual quantity X Standard quantity
(AQ = 4,400 hours) (AQ = 4,400 hours) (SQ = 4,000 hours)
of direct labor of direct labor of direct labor
allowed for actual output

(AP x AQ) (SP x AQ) (SP x SQ)

$18 x 4,400 $20 x 4,400 $20 x 4,000

=$79,200 = $88,000 = $80,000

| |
Price variance? Efficiency variance?
T $79,200 — $88,000 $88,000 — $80,000
=$8,800F = $8,000 U

3 Shortcut formulas: (AP x AQ) — (SP x AQ) (SP X AQ)— (SP x SQ)

= (AP — SP) x AQ = SP X (AQ — SQ)

=($18 — $20) x 4,400 = $20 X (4,400 — 4,000)
=$8,800 F =$8,000 U

T Total variance

=$800F
!
See Exhibit 16.11 for the computation of the direct labor price and efficiency
variances.

Direct Labor Price Variance The direct labor price variance is caused by the
difference between actual and standard labor costs per hour. Peak Division’s direct labor
costs were less than the standard allowed, creating a favorable labor price variance of
$8,800. The explanation given for this favorable labor price variance is that Peak hired
less-experienced employees in August; they were paid a lower-than-standard wage, thus
reducing the average wage rate for all workers to $18.
Wage rates for many companies are set by union contract. If the wage rates used in
setting standards are the same as those in the union contract, labor price variances will
not occur.

Labor Efficiency Variance The labor efficiency variance is a measure of labor

productivity. It is one of the most closely watched variances because production man-
agers usually can control it. Unfavorable labor efficiency variances have many causes,
including the employees themselves. Poorly motivated or poorly trained workers are
less productive; highly motivated and well-trained employees are more likely to gener-
ate favorable efficiency variances. Sometimes poor materials or faulty equipment can
cause productivity problems. Poor supervision and scheduling can lead to unnecessary
idle time.
Production department managers are usually responsible for direct labor efficiency
variances. Scheduling problems can stem from other production departments that have
delayed production. The personnel department could be responsible if the variance
occurs because it provided the wrong type of worker. The $8,000 unfavorable direct labor
efficiency variance at Peak Division (see Exhibit 16.11) was attributed to the inexperi-
enced worker previously mentioned. Note that one event, such as hiring inexperienced
employees, can affect more than one variance.
 Chapter 16 Fundamentals of Variance Analysis 747

Variable Production Overhead

To illustrate the computation of variable production overhead variances, assume the fol-
lowing for Peak:

- Standard costs: 0.05 hour per case @ $12 perhour= ......... $0.60 per case
($12 is the variable production overhead rate)
- Number of cases produced in AuUQUSt .. ................oo.... 80,000
* Actual variable overhead costin August . ..................... $53,680 sé
ms———— Ap R —

See Exhibit 16.12 for the computation of the variable production overhead price and
efficiency variances.

Variable Production Overhead Price Variances The variable overhead

standard rate was derived from a two-step estimation of
1. Costs at various levels of activity.
2. The relationship between those estimated costs and the basis, which is direct labor-
hours at Peak Division.
The variable overhead price variance actually contains some efficiency items as well
as price items. For example, suppose that utilities costs are higher than expected. The
reason for this could be that utility rates are higher than expected or that kilowatt-hours
(kwh) per labor-hour are higher than expected (for example, if workers do not turn off
power switches when machines are not being used). Both are part of the price variance
because together they cause utility costs to be higher than expected. Some companies
separate these components of the variable overhead price variance; this is done for energy
costs in heavy manufacturing companies, for example.
At Peak Division, the $880 unfavorable price variance for August (see Exhibit 16.12)
was attributed to waste in using supplies and recent price increases for petroleum prod-
ucts used to maintain the machines.

Exhibit 16.12 Variable Overhead Variances, August (80,000 Cases)—Peak Division

(1) (2) 3)
Actual Inputs at Flexible Production
Actual Standard Price Budget

Sum of actual variable Standard variable Standard variable overhead

manufacturing overhead price price (SP = $12)
overhead costs (SP=$12) x Standard quantity
X Actual quantity (SQ = 4,000 hours)
(AQ = 4,400 hours) of the overhead base (direct
of the overhead base labor in this example) allowed
for actual output produced

(AP x AQ) (SP x AQ) (SP x SQ)

$53,680 $12 x 4,400 $12 x 4,000

= $52,800 = $48,000
Price variance Efficiency variance
$53,680 — $52,800 $52,800 — $48,000
=$880U =$4,800U
A A
Total variance
=$5,680 U
748 Part IV Management Control Systems

Variable Overhead Efficiency Variance The variable overhead efficiency

variance must be interpreted carefully. It is not related to the use (or efficiency) of vari-
able overhead. It is related to efficiency in using the base on which variable overhead is
applied. For example, Peak applies variable overhead on the basis of direct labor-hours.
Thus, if there is an unfavorable direct labor efficiency variance because actual direct
labor-hours were higher than the standard allowed, there will be a corresponding unfa-
vorable variable overhead efficiency variance. Peak used 400 direct labor-hours more
than the standard allowed, resulting in the following direct labor and variable overhead
efficiency variances:

Direct labor efficiency (Exhibit 16.11)

$20 . 400holls = el fecn (0 e e $ 8,000U
Variable overhead efficiency (Exhibit 16.12)
$12 5400 heUfSE -l e 4,800 U
Total direct labor and variable overhead efficiency variances
$32 0 A00N0UMS = v co S e e e $12,800 U

Variable overhead is assumed to vary directly with direct labor-hours, which is the
base on which variable overhead is applied. Thus, inefficiency in using the base (for exam-
ple, direct labor-hours, machine-hours, units of output) is assumed to cause an increase in
variable overhead. This emphasizes the importance of selecting the proper base for apply-
ing variable overhead. Managers who are responsible for controlling the base will prob-
ably be held responsible for the variable overhead efficiency variance as well. Whoever is
responsible for the $8,000 unfavorable direct labor efficiency variance at Peak should be
held responsible for the unfavorable variable overhead efficiency variance.

Variable Cost Variances Summarized in Graphic Form

See Exhibit 16.13 for a summary of the variable production cost variances. Note that the
total unfavorable variable production cost variance of $25,680 is the same as that derived
in Exhibit 16.5. The cost variance analysis just completed is a more detailed analysis of
the variable production cost variance derived in Exhibit 16.5.

Exhibit 16.13 Variable Manufacturing Cost Variance Summary, August—Peak Division

=
o (AP — SP) x AQ = ($0.60 — $0.55) x 328,000 pounds
Direct materials $16,400 U
20,800 U Effici
$ [ “TICIeNCY spx (4Q — SQ) = $0.55 x (328,000 Ibs. — 320,000 Ibs)
$4,400 U
-
1€ (AP - SP)x AQ = ($18 — $20) X 4,400 hours
Total Direct labor $8,800 F
Effici
$25,680 U : 800 F | =TCIeNSY spx (40 — SQ) = $20 x (4,400 hrs. — 4,000 hrs.)
$8,000 U

Price
Actual — (SP X AQ) = $53,680 — ($12 x 4,400 hrs.)
Variable overhead $880 U

$5,680 U |
ici
Efficiency - 'spx(AQ - SQ) = $12 x (4,400 hrs. — 4,000 hrs)
$4,800 U
 Chapter 16 Fundamentals of Variance Analysis 749

' A summary of this nature is useful for reporting variances to high-level managers. It
provides both an overview of variances and their sources. When used for reporting, the
computations at the right of Exhibit 16.13 usually are replaced with a brief explanation
of the cause of the variance.
Management might want more detailed information about some of the variances.
Extending each variance branch in Exhibit 16.13 to show variances by product line,
department, or other categories can provide this additional detail.

Direct materials purchased and used:

825000maundsat $1.40... . ... $455,000
Direct labor: 19,000 labor-hours at $25 ........ 475,000
Varfable'overheadaiavai. atie . o Lonisas
Direct materials: 3 pounds at $1.50............ $ 4.50
Direct labor: 0.20 labor-hour at $22.50......... 4.50
Variable production overhead:
20 1aborhoir at PAODOD s i v L o 2.00
qfor e = e e SRR, G e e e e

Fixed Cost Variances

Variance analysis treats fixed production costs and variable production costs differently.
et 16-6
Because fixed costs are unchanged when volume changes (at least within the relevant lé:?)m RS SN
range), the amount budgeted for fixed overhead is the same in both the master and flex- tp : it i
cost variances.
ible budgets. This is consistent with the variable costing method of product costing in
which fixed production overhead is treated as a period cost.

Fixed Cost Variances with Variable Costing

The income statements in Exhibit 16.5 were prepared using variable costing. Therefore,
there is no absorption of the fixed costs by units of production. All the fixed manu-
facturing overhead is charged to income in the period incurred. Fixed overhead has no
input—output relationships and, thus, no efficiency variance. The difference between the
flexible budget and the actual fixed overhead is entirely due to changes in the costs that
make up fixed overhead (for example, insurance premiums on the factory are higher than
expected). Hence, the variance falls under the category of a price variance (also called a
spending or budget variance). spending (or budget)
The fixed manufacturing overhead in both the flexible and master budgets in Exhibit variance
16.5 was $200,000. The actual cost was $195,500. See Exhibit 16.14 for the variance ' variance forfixed
analysis. Note that it has no calculation of the efficiency with which inputs are used. o d
750 Part IV Management Control Systems

Exhibit 16.14 Flexible Production

Fixed Overhead Actual Budget?®
Variances, August—Peak
$195,500 $200,000
Division
Price variance: Efficiency variance:
$195,500 — $200,000 Not applicable
= $4,500 F

a For fixed costs, there is no difference between the flexible and master (or static) budget within the
relevant range.

Visualizing Cost Variances

Exhibit 16.15 graphically summarizes the production cost variances by resource type. As
Exhibit 16.15 shows, the largest variance is related to materials. By comparison, both labor
(with a favorable variance) and overhead (with an unfavorable variance) are much smaller.
Exhibit 16.16 provides a more detailed breakdown of these cost variances. Although
the summary information in Exhibit 16.15 is useful to identify potential areas for study,
the results in Exhibit 16.16 show that summarizing variances may lead managers to over-
look potential areas of improvement. In Exhibit 16.16, for example, we see that materials
are certainly a possible area for further analysis, but the detailed results in Exhibit 16.16
show that labor costs might also provide an important area for operation improvements.
Although the overall labor variance is relatively small, the individual components show
that result to be the combination of larger, but offsetting, price and efficiency variances.

Absorption Costing: The Production Volume Variance

So far, we have assumed that fixed manufacturing costs are treated as period costs, which
is consistent with variable costing. If fixed manufacturing costs are unitized and treated
as product costs, another variance is computed. This occurs when companies use full
absorption, standard costing.

Exhibit 16.15 Cost Variances by Manufacturing Resource

Brunswick, Inc.
Peak Division
Production Cost Variance Analysis: By Manufacturing Resource
(Note: Negative Variances Resulted in Lower Profits)

($25,000) ($20,000) ($15,000) ($1O,’,OOO) ($5,000) $0 $5,000

"

Materials

Labor . u]

. Overhead
 Chapter 16 Fundamentals of Variance Analysis 751

Exhibit 16.16 Cost Variances by Manufacturing Resource: Details

Brunswick, Inc.
Peak Division
Production Cost Variance Analysis: Detailed Breakdown
(Note: Negative Variances Resulted in Lower Profits)

($20,000) ($15,000) ($10,000) ($5,000) $0 $5,000 $10,000 $15,000

F oo
% —q

Material price

Material efficiency

Labor price

Labor efficiency

Variable overhead efficiency

Variable overhead price|

Fixed overhead price

r l 3

Developing the Standard Unit Cost for Fixed Production Costs Like
other standard costs, the fixed manufacturing standard cost is determined before the start
of the production period. Unlike standard variable manufacturing costs, fixed costs are
period costs by nature. To convert them to product costs requires estimating both the
period cost and the production volume for the period. From Chapter 7, we know that

Standard (or predetermined) _ Budgeted fixed manufacturing cost

fixed production overhead cost Budgeted activity level

The estimated annual fixed manufacturing overhead at Peak was $2,400,000, and the
annual production volume was estimated to be 1,200,000 cases, or 60,000 direct labor-
hours at .05 hour per case. Thus, Peak determines its standard fixed manufacturing cost
per case as follows:

Standard cost _ $2,400,000 budgeted fixed manufacturing cost _

per case 1,200,000 cases (budgeted activity level) S fbper case

The rate could be computed per direct labor-hour, as follows:

Standard cost _ $2,400,000 budgeted fixed manufacturing cost _ $40.00 per hour
per case ~ 60,000 hours (budgeted activity level) 2

Each case is expected to require .05 direct labor-hour (= 60,000 hours + 1,200,000
cases), so the standard cost per case is still $2 (= $40 per hour X .05 hour per case).
If 80,000 units are actually produced during the month, $160,000 (= $2 per case x
80,000 cases) of fixed overhead costs is applied to these units produced. The production production volume variance
Variance that arises because
volume variance is the difference between the $160,000 applied fixed overhead and the the volume used to apply
$200,000 (= $2,400,000 + 12 months) budgeted fixed overhead as in Exhibit 16.17. In fixed overhead differs from
this situation, a $40,000 unfavorable production volume variance exists. It is unfavorable the estimated volume used to
because less overhead was applied than was budgeted; production was lower than the estimate fixed costs per unit.
752 Part IV Management Control Systems

Exhibit 16.17 (b) (©

(@)
Fixed Overhead Actual Budget Applied
Variances, August—Peak
$195,500 e ‘;$,15Q;poo ;
Division

0U

average monthly estimate. This variance is a result of the full absorption costing system;
it does not occur in variable costing.
This $160,000 applied fixed overhead equals $2 per case multiplied by 80,000 units actu-
ally produced (see Exhibit 16.18). If the $40 rate per direct labor-hour had been used, the
amount applied to the 80,000 units produced would still be $160,000 (= $40 x 0.05 x 80,000).
A variance occurs if the number of units actually produced differs from the num-
ber of units used to estimate the fixed cost per unit. Again, this variance is commonly
referred to as a production volume variance (also called a capacity variance, an idle
capacity variance, or a denominator variance).
Our example has a production volume variance because the 80,000 cases actually pro-
duced during the month do not equal the 100,000 estimated for the month. Consequently,
production is charged $160,000 (point A in Exhibit 16.18) instead of $200,000 (point B
in Exhibit 16.18). The $40,000 difference is the production volume variance because it is
caused by a deviation in production volume level (number of cases produced) from that
estimated to arrive at the standard cost.
If Peak had estimated 80,000 cases per month instead of 100,000 cases, the stan-
dard cost would have been $2.50 per case (= $200,000 + 80,000 cases). Thus, $200,000
(= $2.50 x 80,000 cases) would have been applied to units produced, and there would
have been no production volume variance.

Exhibit 16.18 Fixed Overhead Variances, Graphic Presentation—Peak Division

Buget: $200,000 Budget line

Actual: $195,500

Applied: $160,000

Monthly
activity (cases
80,000 100,000 produced)
cases actually estimate
produced cases
 Chapter 16 Fundamentals of Variance Analysis 753

The production volume variance applies only to fixed costs; it occurs because
‘ we are allocating a fixed period cost to units on a predetermined basis. It does not
represent resources spent or saved. This is unique to full absorption costing. The ben-
efits of calculating the variance for control purposes are questionable. Although the
production volume variance signals a difference between expected and actual produc-
tion levels, so does a simple production report of actual versus expected production
quantities.

Compare with the Fixed Production Cost Price Variance The fixed pro-
duction cost price variance is the difference between actual and budgeted fixed produc-
tion costs. Unlike the production volume variance, the price variance commonly is used
for control purposes because it is a measure of differences between actual and budgeted
period costs.
Exhibits 16.17 and 16.18 summarize the computation of the fixed production price
(spending) and production volume variances. Reviewing them will help you see the rela-
tionship between actual, budgeted, and applied fixed production costs.

Summary of Overhead Variances

The method of computing overhead variances described in this chapter is known as the
Sfour-way analysis of overhead variances because it computes the following four vari-
ances: price and efficiency for variable overhead, and price and production volume for
fixed overhead. See Exhibit 16.19 for a summary of the four-way analysis of variable and
fixed overhead variances based on facts given in the chapter.

Exhibit 16.19 Summary of Overhead Variances, Four-Way Analysis, August—Peak Division

Actual Actual Inputs at Flexible

Standard Price Production Budget

; ($12 x 4,400 ($12 x 4,000 standard hours

actual hours) allowed to make 80,000 cases)
Variable : Price variance: Efficiency variance:
manufacturing $53,680 — $52,800 $52,800 — $48,000

Actual Budget Applied®

$200,000
(both flexible and $160,000
$195,5002 master budget) ($2 x 80,000)
: Production volume
Fixed : Price variance: Efficiency variance: variance:
manufacturing $195,500 — $200,000 Not applicable $200,000 - $160,000
overhead: =$4,500 F = $40,000 U

’ a. Amount given in the chapter.

b. This is the amount of fixed manufacturing cost applied to production when using full
absorption costing.
754 Part IV Management Control Systems

Self-Study Question

3. This question follows up Self-Study Question 2. Assume

that the fixed production cost budget for the month was
$320,000, and actual fixed production overhead costs
were $332,000. The estimated monthly production was
80,000 cases (or 16,000 standard labor-hours). The solution to this question is at the end of the chapter.

Key Points
Several points regarding overhead variances are important:
¢ The variable overhead efficiency variance measures the efficiency in using the allo-
cation base (for example, direct labor-hours).
* The production volume variance occurs only when fixed production cost is unitized
(for example, when using full absorption costing). Furthermore, the budgeted fixed
overhead might not equal the amount applied to units produced.
¢ There is no efficiency variance for fixed production costs. Do not confuse production
volume variance with an efficiency variance.

Does Standard Costing Lead to Overproduction?

Standard costing systems base the reported product costs on the development of standard costs for fixed overhead and
standards, such as those in Exhibit 16.6. Analysts and others consequently for production volume variances. Managers
have long criticized standard costing as motivating behavior evaluated by variances that include production volume
that does not increase company value. For some observers, variances do have an incentive to overproduce. This is the
the problem is that standard costing systems lead manag- reason that performance evaluation systems, including stan-
ers and workers to increase production, even if it only builds dard costing, should be applied with an understanding of
inventory, because the focus is on unit costs. In addition, stan- the undesirable incentives they provide managers. In the
dard costing appears to be an additional system, requiring case of production volume variances, we have noted that
resources to develop and maintain. the variance represents the difference between the actual
As always, it is important to distinguish between a con- production level and the production level used to develop
ceptand a practice. The concept of standard costing is simply the standard cost for fixed overhead. Rarely would this differ-
that firms can create benchmarks against which to evaluate ence reflect managerial performance that a firm would want
performance. Standard costing, as usually practiced, includes to encourage or discourage.

1. Avariance is the difference between an actual and a bud- budget is adjusted for actual sales or actual
geted number: output.
a. Afavorable variance increases operating profits. 2. Greater insights can be gained by decomposing the profit
variance based on the items that make up profit:
b. Anunfavorable variance decreases operating profits.
c. A simple example is a profit variance, calculated as a. Sales activity = (Actual sales — Budgeted sales) x
Profit variance = Actual profit — Budgeted profit. Budgeted contribution margin.
b. Sales price = (Actual price — Budgeted price) x
d. The budget may be based on either the original
Actual sales.
(master) budget or a flexible budget. A flexible

(Continued)
 Chapter 16 Fundamentals of Variance Analysis 755

. (Continued)
¢. Variable manufacturing cost = (Actual variable cost ¢. Fixed cost variances depend on whether the firm is
— Budgeted variable cost) x Budgeted sales. using contribution-margin (variable) costing or
d. Fixed manufacturing cost = (Actual fixed cost — Bud- absorption costing:
geted fixed cost). « Contribution margin costing:
) Selling and administrative (SG&A) (Actual SG&A — . Fixed overhead price = (Actual fixed cost —
i) Budgeted SG&A} Budgeted fixed cost)
' Absorption costmg

SUMMARY
This chapter discusses the computation and analysis of variances. A variance is the difference
between a budget, or standard, and an actual result.
The following summarizes the key ideas tied to the chapter’s learning objectives:

LO 16-1 Use budgets for performance evaluation. Budgets provide a view of anticipated
operations and enable management to measure the performance of employees in various
areas of the production and sales processes.
LO 16-2 Develop and use flexible budgets. The master budget is typically static; that is, it
. is developed in detail for one level of activity. A flexible budget recognizes that vari-
able costs and revenues are expected to differ from the budget if the actual activity (for
example, actual sales volume) differs from what was budgeted. A flexible budget can be
thought of as the costs and revenues that would have been budgeted if the activity level
had been correctly estimated in the master budget. The general relationship between the
actual results, the flexible budget, and the master budget follows:

Actual Flexible Budget Master Budget

Actual costs and revenues C@fit&afidrevenues that would Budgeted costs and
base " “en actual activity i ‘me'béen budgeted if actual revenues based on
: nacwmy had been budgeted budgeted activity

LO 16-3 Compute and interpret the sales activity variance. The sales activity variance is
the difference between the operating profit in the master budget and the flexible budget.
This difference (or variance) occurs because the actual number of units sold is different
from the number budgeted in the master budget.
LO 16-4 Prepare and use a profit variance analysis. The profit variance analysis outlines the
causes of differences between budgeted profits and the actual profits earned. Variances
are separated into four categories: production, marketing and administrative, sales price,
and sales activity.
LO 16-5 Compute and use variable cost variances. The model used for calculating variable
production cost variances is based on the following diagram, which divides the total
variance between actual and standard into price and efficiency components.
756 Part IV Management Control Systems

Q] (2) (3)
Actual Inputs at Flexible Production
Actual Standard Price Budget

Actual input price Standard input price Standard input price

(AP) x Actual quantity (SP) x Actual quantity (SP) x Standard quantity
(AQ) of input (AQ) of input (SQ) of input
allowed for actual output

(AP x AQ) (SP x AQ) (SP x SQ)

Price variance Efficiency variance

M- 2-03)
(AP X AQ) — (SP x AQ) (SP X AQ) — (SP x SQ)
= (AP — SP) x AQ = SP X (AQ - SQ)

Total variance
M-03
(AP x AQ) — (SP x SQ)

LO 16-6 Compute and use fixed cost variances. Fixed production costs have no efficiency
variance. The price variance is the difference between actual fixed costs and the fixed
costs in the flexible budget. If fixed costs are unitized and assigned to units produced, a
production volume variance also can arise. The production volume variance is the dif-
ference between the budgeted fixed costs and the amount applied to production.
LO 16-7 (Appendix) Understand how to record costs in a standard costing system. In a
standard costing system, work in process is recorded at standard costs, and variance
accounts collect the difference between actual and standard costs. Variances are closed
to cost of goods sold (because we assume that production equals sales in this chapter).

KEY TERMS

cost variance analysis, 741 profit variance analysis, 737

efficiency variance, 742 sales activity variance, 735
favorable variance, 732 sales price variance, 737
financial budgets, 731 spending (or budget) variance, 749
flexible budget, 734 standard cost sheet, 740
flexible budget line, 734 standard costing, 756
flexible production budget, 744 static budget, 734
operating budgets, 731 total cost variance, 742
price variance, 742 unfavorable variance, 732
production volume variance, 751 variance, 731

APPENDIX: RECORDING COSTS IN A STANDARD COST SYSTEM

When using standard costing, costs are transferred through the production process at
LO 16-7
their standard costs. This means that the entry debiting Work-in-Process Inventory at
(Appendix) Understand
standard cost could be made before actual costs are known. In process costing, units
how to record costs
transferred between departments are valued at standard cost; in job costing, standard costs
in a standard costing are used to charge the job for its components. Actual costs are accumulated in accounts
system. such as Accounts Payable and Wages Payable and are compared with the standard costs

9
allowed for the output produced. The difference between the actual costs assigned to a
department and the standard cost of the work done is the variance for the department.
standard costing
Accounting method that The following sections discuss the flow of costs in a standard cost system, compare
assigns costs to cost objects at the actual and standard costs of work, and demonstrate how the variances are isolated
predetermined amounts. in the accounting system. The variances are based on the calculations introduced in the
 Chapter 16 Fundamentals of Variance Analysis 757

chapter. Standard cost systems vary somewhat from company to company, so in reality,
the method presented here might be modified to meet a company’s particular needs.
The example in this appendix continues the Peak Division example in this chapter.
All variances were computed earlier in this chapter.

Direct Materials
In the example in this chapter, we assume that materials are purchased as they are used so
that there are no material inventories. In Chapter 17, we discuss the case where the firm
purchases and stores materials prior to use. In August, Peak purchased and used 328,000
pounds of materials and paid $0.60 per pound. The standard for materials is four pounds
of material per case at a standard cost of $0.55 per pound. The information for this entry
comes from Exhibit 16.10.

(Work-in-Process VEIRORE e i . o s 176,000 “X

Matedals:Price VatameEe . i s oty it oiis apsiiins sisime 16,400
Materidls EfficieneyNarianee - cii s oot il in o 4,400
AccountsPavable v s sl Lo s 196,800
To record the purchase and use of 328,000 pounds of material at an actual cost of
$0.60 per pound and the transfer to work in process at a standard use of 4 pounds of
material allowed per case and a standard cost of $0.55 per pound. j

Direct Labor
Direct labor is credited to payroll liability accounts, such as Accrued Payroll or Payroll
Payable, for the actual cost (including accruals for fringe benefits and payroll taxes) and
charged to Work-in-Process Inventory at standard. The following entry is based on the
facts about the standard costs allowed for Peak Division as described in the chapter and
in Exhibit 16.11.

(-Work-in-Process InVamieGRy: e et s i e 80,000 ‘\

Direct Labor Efficiency Variance . ..................... 8,000
Direct'Labor Price Varianee o il Saidiu st i 8,800
Wages Payable: i G o il g e e 79,200
To record the purchase and use of 4,400 hours of direct labor at an actual wage
rate of $18 per hour and the transfer to work in process at a standard use of
\ 0.05 hour of labor allowed per case and a standard cost of $20 per hour. Mfig

Variable Manufacturing Overhead

Standard overhead costs are charged to production based on standard direct labor-hours
per unit of output produced at Peak. Overhead costs often are charged to production
before the actual costs are known. This is demonstrated by the following sequence of
entries:
1. Standard overhead costs are charged to production during the period. The credit entry
is to an overhead applied account.
2. Actual costs are recorded in various accounts and transferred to an overhead sum-
mary account. This accounting procedure is completed after the end of the period.
3. Variances are computed as the difference between the standard costs charged to pro-
duction (overhead applied) and the actual costs.
758 Part IV Management Control Systems

Based on the data from the chapter and Exhibit 16.12, variable overhead is charged
to production as follows:

1. Work-in-Process InVentonys .. .cicv. ioco ool o i 48,000

Variable Overhead (Applied) ...................... 48,000

Note that overhead is applied to Work-in-Process Inventory on the basis of standard

labor-hours allowed. As we shall see shortly, over- or underapplied overhead represents a
combination of the variable overhead price and efficiency variances.
Actual variable overhead costs are recorded in various accounts and transferred to
each department’s variable manufacturing overhead account as follows:

2:-Variable GverRedeilActtal s i e L 53,680

Miscellaneous Payables and Inventory Accounts. ......... 53,680

Variable overhead variances were computed in the chapter (see Exhibit 16.12): price,
$880 U, and efficiency, $4,800 U. These variable overhead variances are recorded by
closing the applied and actual accounts as follows:

3. Variable Overhead (Applied) ...................... 48,000

Variable Overhead Price Variance.................. 880
Variable Overhead Efficiency Variance ............. 4,800
Variable Overhead (Actual). . .................... 53,680

Fixed Manufacturing Overhead

For the purposes of this example, we assume that Peak uses full absorption costing as
we did in the chapter. As with variable overhead, Peak applies fixed overhead based on
standard labor-hours allowed. For Peak, the standard fixed overhead rate is $40 per hour.
First, we record the application of fixed overhead to production:

1." Work-in-Rrocessinventory:sHo o b s il ol iaidndn .o 160,000

Fixed Overhead (Applied)............coiviiiiiiity 160,000

Next, Peak records the acquisition or use of actual fixed overhead:

2. Eixed:Overhead{Actual): B s luti Doyl h o an il ol 195,500

Miscellaneous Payables and Inventory Accounts. . .. ... 195,500

Finally, Peak records the fixed overhead variances and closes the actual and applied fixed
overhead accounts:

3. Fixed Overhead (Applied)............cccovvvin... 160,000

Fixed Overhead Production Volume Variance ........ 40,000
Fixed Overhead Price Variance .. ................ 4,500
Fixead'Overhedad (Actlas .. oe i s i s 195,500
 Chapter 16 Fundamentals of Variance Analysis 759

Transfer to Finished Goods Inventory and to

Cost of Goods Sold
When all production work has been completed, units are transferred to Finished Goods
Inventory and to Cost of Goods Sold at standard cost.

Finished Goods Inventory This month, 80,000 cases were finished and
transferred to Finished Goods Inventory. The standard unit cost of a case is $5.80 (=
$3.80 variable cost + $2 applied fixed overhead). After they have been finished and
inspected, the cases are transferred to a finished goods storage area and recorded by
the following entry:

SRS CONOEINVERIDNY .. coiv . e 464,000

Watlcin-BrocessInVentony: ses o i loi 464,000 E
To record the transfer of 80,000 cases to finished goods inventory at a standard
cost of $5.80 per case.

Cost of Goods Sold For this example, assume that the company sold all 80,000 of
the cases it produced for $10 per case. This was recorded by the following entries:

(Accounts Recevables o s s o il e e 800,000 \*

SAleSIREVENUE ;L o . i il st A i eyt a2 800,000
CosholGoads Solelt i wer it b me i A s n L 464,000
EiRished GOodsHAVERIONY v ies i s v R us 464,000

To record the sale of 80,000 cases at a price of $10 per case and a standard unit
cost of $5.80 per case.
\. >
Close Out Variance Accounts to Cost of Goods Sold
In the chapter, sales were assumed to equal production, so there were no ending invento-
ries. (We explicitly consider in more detail the case of production not equaling sales in
Chapter 17.) In this example, we assume that the company closes all variance accounts to
Cost of Goods Sold. In many firms, this will occur at the end of the year, but we assume,
for illustrative purposes, that Peak Division closes all variance accounts at the end of the
month. The following entries accomplish this:

(Cost ofGoods Soldt i v v D e s 61,180 N

RPirectiabor Price NVariance /o k. o i i s e ee 8,800
Fixed Overhead Price Variance....................... 4,500
Maletials PHCONVAMHBRCe 7 s i ia i et o, 16,400
Materials Efficieney:Nariance.... c.o i cabaei e, s 4,400
Direct Labor Efficiency Variance.................... 8,000
Variable Overhead Price Variance .................. 880
Variable Overhead Efficiency Variance .............. 4,800
Fixed Overhead Production Volume Variance ........ 40,000

To close the variance accounts to Cost of Goods Sold.

760 Part IV Management Control Systems

REVIEW QUESTIONS
16-1. What are the advantages of the contribution margin format based on variable costing com-
pared to the traditional format based on full absorption costing?
16-2. How can a budget be used for performance evaluation?
16-3. “The flexible budget for costs is computed by multiplying average total cost at the master
budget activity level by the activity at some other level.” Is this true or false? Explain.
16-4. A flexible budget is
a. Appropriate for control of factory overhead but not for control of direct materials and
direct labor.
b. Appropriate for control of direct materials and direct labor but not for control of fac-
tory overhead.
c. Not appropriate when costs and expenses are affected by fluctuations in volume.
Appropriate for any level of activity.
(CPA adapted)
16-5. What is the standard cost sheet?
16-6. What is the basic difference between a master budget and a flexible budget?
a. A flexible budget considers only variable costs; a master budget considers all costs.
b. A master budget is based on a predicted level of activity; a flexible budget is based on
the actual level of activity.
c. A master budget is for an entire production facility; a flexible budget is applicable
only to individual departments.
d. A flexible budget allows management latitude in meeting goals; a master budget is
based on a fixed standard.
(CPA adapted)
16-7. Standards and budgets are the same thing. True or false?
16-8. Actual direct materials costs differ from the master budget amount. What are the three
primary reasons for the difference?
16-9. Fixed cost variances are computed differently from the variances for variable costs. Why?
J
16-10. How are actual direct labor costs used in a standard cost system? Does this differ from their
use in a normal costing system? If so, how? If not, why not?

CRITICAL ANALYSIS AND DISCUSSION QUESTIONS

16-11. What is the advantage of preparing the flexible budget? The period is over and the actual
results are known. Is this just extra work for the staff?
16-12. What is the link between flexible budgeting and management control?
16-13. “Actual revenues are greater than budgeted for December, so our revenue variance is
favorable.” Give an example of when this would be “good” news and when it could be
“bad” news.
16-14. Pick an organization you know, such as a school, a local firm, a business, an entertain-
ment business, a sports team, and so on. Identify an example of when a favorable cost
variance (actual cost relative to a budget) is not good news for the performance of the
organization.
16-15. Give two reasons why dividing production cost variances into price and efficiency vari-
ances is useful for management control.
16-16. A rush order for a major customer has led to considerable overtime and an unfavorable
variance for production costs. Is this variance the responsibility of the marketing manager,
the production manager, both, neither, or someone else?
16-17. “My firm has a wage contract with the union. Therefore, we do not need to compute a labor
price variance; it will always be zero.” Comment.
16-18. The production volume variance indicates whether a company has spent more or less than
called for in the budget. True or false?
16-19. The production volume variance should be charged to the production manager. Do you
agree? Why or why not?
 Chapter 16 Fundamentals of Variance Analysis 761

16-20. A CEO tells you, “Division A always reports large, favorable variances. This saves us a lot
of time because we do not have to spend time reviewing their results.” Comment.
16-21. “Production cost variances are not useful in my company. There is substantial learning that
takes place, so we are more efficient, the more we produce. A standard cost sheet doesn’t
reflect that.” Do you agree?
16-22. Reviewing the variance report for one of the manufacturing plants in your company, you
see a large unfavorable fixed cost price variance and large favorable production volume
variance. You contact the plant controller, who says that there is no problem: “The two
variances together are almost zero.” How would you respond?

[ o
All applicable Exercises are included in Connect. (:om EXE RC'SES

16-23. Flexible Budgeting (LO 16-2)

The master budget at Monroe Manufacturing last period called for sales of 42,000 units at $42
each. The costs were estimated to be $26 variable per unit and $524,000 fixed. During the period,
actual production and actual sales were 45,000 units. The selling price was $41 per unit. Variable
costs were $28 per unit. Actual fixed costs were $515,000.

Required
Prepare a flexible budget for Monroe Manufacturing.

16-24. Sales Activity Variance (LO 16-3)

Refer to the data in Exercise 16-23.

Required
. Prepare a sales activity variance analysis like the one in Exhibit 16.4.

16-25. Profit Variance Analysis (LO 16-4)

Refer to the data in Exercises 16-23 and 16-24.

Required
Prepare a profit variance analysis like the one in Exhibit 16.5.

16-26. Flexible Budgeting (LO 16-2)

The master budget at Cherrylawn Corporation at the beginning of the year was based on sales of
275,000 units with revenues of $3,300,000. Total variable costs were budgeted at $1,925,000 and
fixed costs at $950,000. During the period, actual production and actual sales were 255,000 units.
The actual revenues were $3,442,500. Actual variable costs were $6.50 per unit. Actual fixed costs
were $980,000.

Required
Prepare a flexible budget for Cherrylawn Corporation.

16-27. Sales Activity Variance (LO 16-3)

Refer to the data in Exercise 16-26.

Required
Prepare a sales activity variance analysis like the one in Exhibit 16.4.

16-28. Profit Variance Analysis (LO 16-4)

Refer to the data in Exercises 16-26 and 16-27.
762 Part IV Management Control Systems

Costs

$61,000

FB

$43,000

$25,000

4,000 units 6,000 units Activity

Actual Planned per month
activity activity

Required
Given the data shown in the graph, determine the following:
a. Budgeted fixed cost per period.
b. Budgeted variable cost per unit.
c Value of FB (that is, the flexible budget for an activity level of 4,000 units).
d. Flexible budget cost amount if the actual activity had been 12,000 units.
(LO 16-2) 16-30. Fill in Amounts on Flexible Budget Graph
The following graph is from Welton Associates.

Required
Find the missing amounts for (a) and (b).

profit
Master budget
=$66,000

Operating Flexible budget

= $12,000
$0

loss

Operating

Fixed costs
= $150,000
 Chapter 16 Fundamentals of Variance Analysis 763

16-31. Flexible Budget (LO 16-2)

' The following graph is from Floyd & Company.

Required
Label (a) and (b) in the graph and give the number of units sold for each.

& $
‘5
0.
o
£
©
9]
o
O Flexible budget
=$178,000

$0
Master budget
w =$(95,000)
12}
o
()]
=
©
[}
£
o Fixed costs
= $680,000

16-32. Prepare Flexible Budget (LO 16-2)

Fournier Fixtures produces a variety of manufactured items for the home and building industry.
The company produces only when it receives orders and, therefore, has no inventories. The follow-
ing information is available for the current month:

( Master Budget ‘\
Actual (based on (based on budgeted
actual orders for orders for
392,000 units) 350,000 units)

Salcseveniie: s a i $7,448,000 $7,000,000

Less
Variable costs
Materials . ... ... i v dag i e 2,600,000 2,310,000
Bifectilaborut i iy o 230,000 210,000
Variable overhead ............... 1,180,000 1,050,000
Variable marketing and
administrative 5L /cosi i deathans 860,000 770,000
Totalivariable costs:. .. .l o by $4,870,000 $4,340,000
Contibutionmardine:, Tr 2oa s TRl $2,578,000 $2,660,000

Less
Fixed costs
Manufacturing overhead ......... 1,560,000 1,580,000
Markelingus il i i s 475,000 460,000
. R BIAIG 1 1ot s o5 o 300,000 325,000
fotabxedicosts . .. b . b $2,335,000 $2,365,000
@pErAHNGPIOfits .l i $ 243,000 $ 295,000
 Part IV Management Control Systems

Required
Prepare a flexible budget for Fournier Fixtures. ‘

(LO 16-3) 16-33. Sales Activity Variance

Refer to the data in Exercise 16-32.

Required
Prepare a sales activity variance analysis for Fournier Fixtures like the one in Exhibit 16.4.

(LO 16-4) 16-34. Profit Variance Analysis

Refer to the data in Exercise 16-32 and the analysis in Exercise 16-33.

Required
Prepare a profit variance analysis for Fournier Fixtures like the one in Exhibit 16.5.

(LO 16-3) 16-35. Sales Activity Variance

The following data are available for the most recent year of operations for Prest Products. The rev-
enue portion of the sales activity variance is $225,000 U.

/' Master budget based on budgeted sales of 45,000 units:

I o eenie o ea . Rl e $1,500,000
o Matmialssit 0 0 510,000
% lFabor &b s ia i e s e e 375,000
i Variable manufacturing overhead and administrative costs . .. .. 75,000
%& Fixed manufacturing overhead and administrative costs. . ; 180,000

Required
a. How many units were actually sold in the most recent period?
b. Prepare a sales activity variance for the most recent year for Prest Products. '

(LO 16-3) 16-36. Sales Activity Variance

Selected data for March for Irvington, Inc. follow. The variable material sales activity variance is
$21,600 U.

.;;’v"y B N

| Flexible budget based on actual sales of 9,750 units: ’

REVERUE S i ot R bl e e e e $280,540
Materials 93,600 é
Labor 73,840 |
. Variable overhead 46,800 g
% Fixed costs (manufacturing and administrative). 40,800 _4

Required
a. How many units were budgeted for March in the master budget?
b. Recreate the master budget for March.

(LO 16-1) 16-37. Assigning Responsibility

Engleside Components produces testing equipment for medical devices. Recently, one of the com-
pany’s usual suppliers was unable to fill an order, so the purchasing manager chose a supplier who
had been approved. The price was significantly higher than the original supplier and the variance
in manufacturing costs was charged to the purchasing department. Working with the new part
turned out to be much easier than with the initial part and the labor required was significantly
lower. The production department was credited with the favorable variance on labor costs.
The purchasing manager argues that the purchasing department should receive some or most
of the credit for the labor savings because it was their choice of vendor that resulted in using the
new part. The production manager responds that the system is consistent with how variances have ‘
been assigned in the past.
 Chapter 16 Fundamentals of Variance Analysis 765

16-38. Flexible Budget (LO 16-2)

Golden Food Products produces special-formula pet food. The company carries no inven-
tories. The master budget calls for the company to manufacture and sell 120,000 cases at a
budgeted price of $60 per case this year. The standard direct cost sheet for one case of pet food
follows:

Direct:materialsisitfiise i ing (3 pounds @ $2) $6

Directlaborii s did (0.25 hour @ $32) 8

Variable overhead is applied based on direct labor-hours. The variable overhead rate is
$16 per direct labor-hour. The fixed overhead rate (at the master budget level of activity)
is $12 per unit. All nonmanufacturing costs are fixed and are budgeted at $2.2 million for the
coming year.
At the end of the year, the costs analyst reported that the sales activity variance for the year
was $336,000 favorable.

Required
Prepare a flexible budget for Golden Food Products for the year.

16-39. Profit Variance Analysis (LO 16-4)

Refer to the information in Exercise 16-38. The following is the actual income statement (in thou-
sands of dollars) for the year for Golden Food Products:

(Sales revenuet s s e B S e e $7,800 \

Less variable costs
DirectimatariBlsass vl gt s s L 800
Birectlabor | L i sl s s el 992
Variable ovetheadic, i s o s an DLl L 515
Totalvariablelgosts ®n it o s oLl $2,307
Contribution'margin.s s BeE A e DESE G Sinh $5,493
Less fixed costs
Fixed manufacturingoverhead ..................... 1,480
Nohmanufactuiiing OSts alus (LRl a0t Sl Flid oo 2,125
Totalifixediaostsl i pea il s L $3,605
@petatind:profits o iian ol e L

Required
Prepare a profit variance analysis like the one in Exhibit 16.5.

16-40. Variable Cost Variances (LO 16-5)

Refer to the information in Exercises 16-38 and 16-39. During the year, the company purchased
320,000 pounds of material and employed 32,500 hours of direct labor.

Required
a. Compute the direct materials price and efficiency variances.
b. Compute the direct labor price and efficiency variances.
¢. Compute the variable overhead price and efficiency variances.

16-41. Variable Cost Variances (LO 16-5)

The standard direct material cost per unit for Willis Group was $124 (= $31 per gallon x 4 gallons
per unit). During the period, actual direct materials costs amounted to $1,635,480, materials used
totaled 55,440 gallons, and 13,200 units were produced.
 Part IV Management Control Systems

(LO 16-5) 16-42. Variable Cost Variances

Records at the Farnsworth Corporation contained the following data for the most recent period of
activity:

§ Actualtotalidirectlaborcostee anea oo oot o e $468,100

L. Actusl direct isbonBBR WoRSH o L e e e 15,100
%fi Standard direct labor-hours allowed for actual output (flexible budget) . . . .. 14,200 {
i% Direct [abol price Varaee Sk Gl BNl s o i A A $45,300F
| Actual variable overhead. .............. ... $347,300
# Standard variable overhead rate per standard direct labor-hour........... $22~(¢§

Variable overhead is applied based on standard direct labor-hours allowed.

Required
Compute the labor and variable overhead price and efficiency variances.

(LO 16-5) 16-43. Variable Cost Variances ‘

The records of Heritage Home Supplies show the following for July:

~ Standard direct labor-hours allowed pelutitoiouipat: - T e 4“\

Standard variable overhead rate per standard direct labor-hour ........... $24
Good unitsproduead: sk s e s e e e A 3,400
Actual directiaboEROUISIWARKET . =000, 0 13175
Actualdcialdirect iabeieOsi i st cos i oL o e T e e $483,200
Directlabor effleieneVaVRIaNGCE /v ol i e $15,810F
Actuahvariablepverheatlss oo e eaas o v T e R e $316,200
. R Sl i e A mm@xwxmw&mwmmfimmwmw@”

Required
Compute the direct labor and variable overhead price and efficiency variances.

(LO 16-5,7) 16-44. (Appendix used in requirement [b]) Variable Cost Variances
Rankin Fabrication reports the following information with respect to its direct materials:

éfi"f Actual quantities of direct materials used. . ...... 33,600 gallons

- Actual costs of direct materials used............ $186,480
% Standard price per unit of direct materials . ...... $5.60 ]
', Flexible budget for direct materials ............. $196,000 J

Rankin Fabrication holds no materials inventories.

Required
a. Prepare a short report for Rankin’s management showing direct materials price and efficiency
variances.
b. (Appendix) Prepare the journal entries to record the purchase and use of the direct materials
using standard costing.

(LO 16-5,7) 16-45. (Appendix used in requirement [b]) Variable Cost Variances
Information on Chicago Crafters direct materials costs follows:

f s’i?()uantities of alloy purchased and used ... . ... .. 77,200 pounds %‘?
Actialicostiofalloyiised = -0 $3,782,800 ‘
- Standard price per pound of alloy ............ $47.00
%tandard quantity of alloy allowed . ........... 80,000 pounds J

Chicago Crafters carries no materials inventories.

 Chapter 16 Fundamentals of Variance Analysis 767

Required
a. What were Chicago Crafters’ direct materials price and efficiency variances?
b. (Appendix) Prepare the journal entries to record the purchase and use of alloy using standard
costing.

16-46. Fixed Cost Variances (LO 16-6)

Information on Grixdale Partner’s fixed overhead costs follows:

Overhead applied $1,225,000

Actual overhead 1,149,000

Required
What are the fixed overhead price and production volume variances? (Refer to Exhibit 16.17 for
the format to use.)

16-47. Graphical Presentation (LO 16-6)

Refer to the data in Exercise 16-46. Management would like to see results reported graphically.

Required
Prepare a graph like that shown in Exhibit 16.18.

16-48. Fixed Cost Variances (LO 16-6)

Coe Parts applies fixed overhead at the rate of $6.80 per unit. Budgeted fixed overhead was
$197,200. This month 28,120 units were produced, and actual fixed overhead was $192,100.

Required
a. What are the fixed overhead price and production volume variances for Coe Parts?
b. What was budgeted production for the month?

16-49. Fixed Cost Variances (LO 16-6)

Annland Components applies fixed overhead at the rate of $5.10 per unit. For October, budgeted
fixed overhead was $513,825. The production volume variance amounted to $3,825 favorable, and
the price variance was $12,750 unfavorable.

Required
a. What was the budgeted volume in units for October?
b. What was the actual volume of units produced in October?
¢. What was the actual fixed overhead incurred for October?

16-50. Fixed Cost Variances (LO 16-6)

Refer to the information in Exercises 16-38 and 16-39.

Required
What are the fixed overhead price and production volume variances for Golden Food Products?

16-51. Overhead Variances (LO 16-5, 6)

The (partial) cost sheet for the single product manufactured at Briarcliff Corporation follows:

EiEstabon. i hhibhes o i s (2 hours @ $30) $60

Netiable overhead . . 1i. i s i s (2 hours @ $9) 18
Eixedioverhead: i a.«idi s 5 vaiitionss (2 hours @ $11) 22
768 Part IV Management Control Systems

The master budget level of production is 45,000 direct labor-hours, which is also the produc- ‘
tion volume used to compute the fixed overhead application rate. Other information available for
operations over the past accounting period include the following:

{ Actual variable overheadincurred................oooiiiiiin $ 411,000 b|

I Actusifixed oueMIERd INEIIEEE. . .. . .............ccconrihaiin 463,000
Directlabor effleienGYVaRaHEe =i . s il L L S 63,000 F |
Variable overhead price variance. 6,000 zj
i ¥ 3 e e e R

Required
a. What was the variable overhead efficiency variance?
b. What was the fixed overhead price variance?
c. What was the fixed overhead production volume variance?

(LO 16-5, 6,7) 16-52. (Appendix used in requirement [c]) Comprehensive Cost Variance Analysis
The River Plant of Carlisle, Inc. produces a particular metal fixture used in aerospace and maritime
industries. The following information is available for the last operating month:
¢ The plant produced and sold 27,600 fixtures for $72 each. Budgeted production was 30,000
fixtures.
e Standard variable costs per fixture follow:

ggsjbirect materialssd porndsiatilBal L o it el oL o R $ 16.00\“?%

| Directisbor. O BORERERRE L. ... . 000G RO U e 400
Variable production overhead: 0.4 machine-hour at $20 per hour . ... ..
Total:variable GOSts el vdlierd 20 (s i L ek R $28.00

¢ Fixed production overhead costs:

{ Monthlybudget. .o, ..o iooi e iiieiinenisse, $810,000

.
o i

* Fixed overhead is applied at the rate of $30 per fixture.

¢ Actual production costs:
0y
b
g Direct materials purchased and used: 105,000 pounds at $4.20 ..... $441,000\§
| Directlabor: 2730 BEUS MERA0E0.. .. .. i i 110,565 |
{i Variable overhead: 12,000 machine-hours at $19.40 perhour . ... ... 232,800
\ Fixedoverhead... ... ..i... oty

Required
a. Prepare a cost variance analysis for each variable cost for the River Plant.
b. Prepare a fixed overhead cost variance analysis.
¢. (Appendix) Prepare the journal entries to record the activity for the last period using standard cost-
ing. Assume that all variances are closed to Cost of Goods Sold at the end of the operating period.

16-53. Comprehensive Cost Variance Analysis

Wetherbee Tech Services (WTS) is a chain of computer maintenance technicians for households
and small businesses. The following data are available for last year’s services:
* WTS recorded 120,000 tech calls last year. It had budgeted 125,000 calls, averaging 90 minutes
each.
® Standard variable labor and support costs per tech call were as follows: ‘

Direct IT specialist services: 90 minutes at $54 perhour . ....................... $81 ‘\%

Variable support staff, supplies, and overhead: 30 minutes at $24 perhour ....... 12t
o
 Chapter 16 Fundamentals of Variance Analysis 769

* Fixed overhead costs:

¢ Fixed overhead is applied at the rate of $36 per call.

® Actual tech service call costs:

Direct IT specialist services: 120,000 calls averaging

84 minutes at $56.00 per hour $9,408,000
Variable support staff, supplies, and overhead: averaging

Required
a. Prepare a cost variance analysis for each variable cost for last year.
b. Prepare a fixed overhead cost variance analysis like the one in Exhibit 16.17.

16-54. Overhead Variances (LO 16-5, 6)

The Faraday Plant of Hindle, Inc. shows the following overhead information for the current period:

@tual overhead incurred. .......... $630,000 ($165,600 fixed and $464,400 variable)
Budgeted fixed overhead .......... $168,480 (8,640 direct labor-hours budgeted)
Standard variable overhead
rate per direct labor-hour. ........ $45
Standard hours allowed
for actual production:............: 10,080 hours
Actual labor-hoursused............ 10,440 hours
R R

Required
What are the variable overhead price and efficiency variances and the fixed overhead price variance?

All applicable Exercises are included in Connect. PROBLEMS

16-55. Solve for Master Budget Given Actual Results (LO 16-2,4)
The following are the actual results for Bentler Associates for the most recent period:

(Sales Volume: s Sdnie Pei i e s L L 63,360 unitA

Salesirevenue - b ol e el $823,680
Variable costs
Mantfacltpings S i g i s i s 190,080
Marketing and administrative .................. 38,550
ContibutionImaNgInG it 2h s ool Lk $595,050
Fixed costs
MBnRUfactURRg. =. s s 8 el Rl L 371,500
Marketing and administrative .................. 103,450
@peratingiprofitis . PVl e $120,100
770 Part IV Management Control Systems

Required
a. Construct the master budget for the period.
b. Prepare a profit variance analysis like the one in Exhibit 16.5.

(LO 16-4) 16-56. Find Missing Data for Profit Variance Analysis
The following, partially complete profit variance analysis is from October for La Salle
Manufacturing:

( Reported \
Income Marketing and Sales Flexible Sales Master
Statement Manufacturing Administrative Price Budget Activity Budget
(18,000 units) Variance Variance Variance ([a]units) Variance (19,200 units)

Salesrevenue .............. $468,000 (b) $486,000 (@] (d)

Variable manufacturing costs. . (e) $14,400 F () $9,120 F (9)
Variable marketing and
administrative costs . . . .. .. (h) (i) (j) (k) $57,600
entribution Mg sl $297,600 U] (m) (n) (o) (p) (q) J

Required
Find the values of the missing items (a) through (q). Assume that the actual sales volume equals
actual production volume. (There are no inventory level changes.)

(LO 16-4) 16-57. Find Data for Profit Variance Analysis

McCoy Industries has prepared the following, partially complete profit variance analysis:

f/ Reported Flexible Mastefi

Income Budget Budget
Statement (based (based on
(based on Marketing and Sales onactual Sales budgeted
actual sales Manufacturing Administrative Price sales Activity sales
volume) Variance Variance Variance volume) Variance volume)

Ripitsss o Dl e o) (a) (b) 10,000 F 50,000

Salesrevenue ................. (9) $16,200 F (h) (i) $135,000
Less
Variable manufacturing
GOSIS e D (n) (o) $86,400 (j) $72,000
Variable marketing and
administrative costs . ....... $19,440 (p) $21,600 $3,600 U (c)
Contribution margin............ (q) $8,100 U (s) (x) $54,000 (k) $45,000
Fixed manufacturing costs . ... (r 1,800 F (m) (d)
Fixed marketing and
administrative costs . ....... 16,200 (v) $13,500 (e)
Qperating BIOBtS . i (t) (u) (w) $16,200 F $18,000 [0) (f) J

Required
Find the values of the missing items (a) through (x). Assume that actual sales volume equals actual
production volume. (There are no inventory level changes.)

(LO 16-2)
 Chapter 16 Fundamentals of Variance Analysis

( Actual (based on Master Budget (baseh

actual sales of on budgeted sales of
4,800 units) 4,000 units)
Salesirevenue: . ikt $228,700 $188,000
Less
Manufacturing costs
Do e ofo] i st B bt ek sl e 50,302 39,000
Materials e o s bl s 31,520 27.200
Variableloverhead: .. ... s i 16,608 13,100
MSHating: s it b Lo 7,805 6,200
Administrative | ... o o R 5219 6,500
lotalyvariableicosts b o il $113,450 $92,000
Coptibution'margin:. f s i e $115,250 $96,000
Fixed costs
Mantifaeturing s .o s S ey 38,930 37,400
Markeling o ekt 14,860 12,200
acministrative . ... 4. ke a i 9,510 10,400
IBtalfixedicostsa e, v D it $63,300 $60,000
kOperating Profitsss = faas et aii il $51,950 $36,000 J

There are no inventories.

Required
Prepare a flexible budget for Nottingham Forest Products.

16-59. Sales Activity Variance (LO 16-3)

Refer to the data in Problem 16-58.
Required
Prepare a sales activity variance analysis for Nottingham Forest Products like the one in Exhibit 16.4.

16-60. Profit Variance Analysis (LO 16-4)

Refer to the data in Problem 16-58.

Required
Use the information for Nottingham Forest Products in Problem 16-58 to prepare a profit variance
analysis like the one in Exhibit 16.5.

16-61. Prepare Flexible Budget (LO 16-2)

The results for March for Savery Parts follow:

( Actual (based on Master Budget (basa

actual sales of on budgeted sales of
14,700 units) 17,500 units)
Salesirevenuest!a. ity VINAOT AgE $263,865 $318,500
Less
Variable costs
Ditectmaterial. . .. MHUSICRE chiie s 51.520 63,100
BT (E(er =] o] o] pRAERF EBEER BV NN S e (e 44102 52,300
Variable overhead. b+, .. 0. . iiiive 34,103 41,200
Mdiketing - 0o doe o et 12,204 13,100
Administratiomiumn SG.A00 Sariig vl 18,191 21,400
Totalivariable costs. (0l d ... ooin, $160,120 $191,100
Copitibution mar@insl s e & v oL $103,745 $127,400
Less
Fixed costs
Magtifactiiping e ol 36,460 33,000
Marketing. Ll i on i ed UL Sl g BIY 16,802 15,000
pemmistration . .- oA e U 24,506 27,000
golElifedicosts: . b0 T G e $ 77,768 $ 75,000
cperating phofits sl e alinRiedn $ 125,977 $ 52,400 )
772 Part IV Management Control Systems

Required
Prepare a flexible budget for Savery Parts for March. ‘

(LO 16-3) 16-62. Sales Activity Variance

Refer to the data in Problem 16-61.

Required
Prepare a sales activity variance analysis for Savery Parts for March like the one in Exhibit 16.4.

(LO 16-4) 16-63. Profit Variance Analysis

Refer to the data in Problem 16-61.

Required
Prepare a profit variance analysis for Savery Parts for March like the one in Exhibit 16.5.

(LO 16-5) 16-64. Direct Materials

Information about direct materials cost follows for Jennings Chemicals:

Standard price per gallon

Actual quantity used 4,370 gallons

Required
What was the actual purchase price per gallon?

(LO 16-5) 16-65. Solve for Direct Labor-Hours

Parkdale Courier Service employs several delivery specialists. The following reports the informa- ‘
tion for these specialists for April:

Standard hours allowed for actual deliveries 16,400 hours

Labor efficiency variance $14,560 U

Required
Based on these data, what was the number of actual hours worked and what was the labor price
variance?

(LO 16-5, 6) 16-66. Overhead Variances

Monitor Devices shows the following overhead information for the current period.

Gjdgeted fixedoverhead (e memes i o0 $460,000 \

Standard variable overhead rate
permachine-hour. & i . SBERRE: . oo ii $52
Standard machine-hours allowed for
actuglipraduction o o SRR L 00 5,320 hours
Actualioverliead incurred .. .o 8 oG TE a0 i $730,800, 60% of which is fixed
&ctual machine-hours used:: @V EO . o . v o 5,435 hours J

Required
What are the variable overhead price and efficiency variances and fixed overhead price variance? ‘

(LO 16-5)
 Chapter 16 Fundamentals of Variance Analysis 773

The following information relates to the current period:

Standard costs (per unit of output)

Direct materials, 5 pounds @ $12.00 per pound . ...... $60
Direct labor, 1.5 hours @ $30 perhour. ............... 45
Factory overhead
Vapable (30% of [Link]). .. .o oo tiviiviinesnns 18
Totalstandard costpartifitic: .o .00 5 o e $123

Actual costs and activities for the month follow:

Materialsilised: - it 7o 26,300 pounds at $12.40 per pound

OUtpEe - e s b 5,500 units
Actualifabor costs i .iss iiee. 8,940 hours at $32 per hour
Actual variable overhead. . . ... $95,790

Required
Prepare a cost variance analysis for the variable costs.

16-68. Overhead Cost and Variance Relationships (LO 16-5, 6)

The following partial information is contained in the variance analysis received from the Western
Plant of Eastlawn Company. All plants at Eastlawn apply overhead on the basis of direct labor-hours.

Gexible budget for variable overhead based \

on 3500 dirgct labOrERours it e T $98,000
Actual total overhead incurred . ...................... $489,300
Actual direct labor-hours worked. .................... 3562
Direct labor-hours used to determined the fixed
overhead applicatiopdaie ., .. ol 0. oo i 3,250
Price variance for variable overhead.................. $6,450 F
\irice variance forfixedioverhead i dvan vl ot $12,514 U

Required
a. Prepare a variable overhead analysis like the one in Exhibit 16.12.
b. Prepare a fixed overhead analysis like the one in Exhibit 16.17.

16-69. Analysis of Cost Reports (LO 16-1,4)

The following is a typical monthly report used to evaluate managers at the six manufacturing
plants of Missouri Foundries:

( (PLANT NAME} \
Cost Report
For the Month of (MONTH}
Master Budget Actual Cost Excess Cost
Raw:materialis .. ........ $540,000 $552,600 $12,600
Directlabor. fi. .. o o v 228,000 225,200 (2,800)
@vethead: . ¥ s 180,000 197,280 17,280
fotall - Rt s $948,000 $975,080 $27,080

Required
Identify and explain at least three changes to the report that would make the cost information more
meaningful and less threatening to the production managers.
774 Part IV Management Control Systems

(LO 16-1) 16-70. Change of Policy to Improve Productivity

Hart Business Solutions operates call centers for multiple clients. Hart has suffered declining prof- .
its and is looking at ways to improve its performance. Because of competition in the industry, Hart
managers do not believe they can raise prices without worsening the problem. It must either cut
costs or improve productivity.
The company uses a standard cost system to evaluate the performance of the call center
staff, specifically the operators who handle 95 percent of all calls. It investigates all unfavorable
variances at the end of the month. The average time taken for a call rarely is less than the stan-
dard, resulting (in the managers’ opinions) unnecessarily in extra staff (and higher costs). In most
months, the variance is small, but generally unfavorable. The solutions that Hart managers decide
to adopt is to lower the standard time allowed for a call. The center supervisor has informed the
operators that they are expected to meet these new standards, just as they came close to the older
standards.

Required
Will the lowering of the standard costs (by reducing the standard time of a call) result in improved
profit margins and increased productivity? Explain.
(CMA adapted)

(LO 16-5, 6) 16-71. Comprehensive Variance Problem

The Valley Plant of Patton Supply manufactures a single product. The standard cost sheet for the
product follows:

" Direct materials, 2 pounds at $10.00 per pound. ............. $20\

Direct [abor. .08 hourat$8d. 25 perholir. . .. . ... .o .. 25
Factory overhead applied at 120% of direct labor
(variable costs = $18; fixed costs =$12)................... 30
Variable selling and administrative cost ..................... 10
Fixed selling and administrativecost........................ 22 ‘
TolalURIECOSE s i g b s R $97
TR R

Standards have been computed based on a master budget activity level of 20,000 direct labor-
hours per month. Actual activity for the past month was as follows:
e e
Materialsused ............ 46,500 pounds at $9.90 per pound %
Direct|labof. &% ALt o 17,800 hours at $32 per hour ;
Total factory overhead . .. .. $657,000
Production .2 i aiaiteee 22,500 units j

Required
a. Prepare variance analyses for the variable and fixed costs. Indicate which variances cannot be
computed. Materials are purchased as they are used.
b. Complete the following table with the total variance for a resource. Be sure to indicate whether
the variance is favorable or unfavorable. If the total cannot be determined, enter a “?”.

gm Resource Amount U/F \

Direct materials s

(LO 16-7)
 Chapter 16 Fundamentals of Variance Analysis 775

Required
Prepare the journal entries to record the activity for the last month using standard costing. Assume
that all variances are closed to Cost of Goods Sold at the end of the month.

16-73. Find Actual and Budget Amounts from Variances (LO 16-5, 6)
Copland Components manufactures an electronic device for vehicle manufacturing. The current
standard cost sheet for a device follows:

Direct materials, ? ounces at $2.80 per ounce....... $ ? per device

Direct labor, 0.4 hourat? perhour ................ ? per device
Overhead, 0.4 hour at? perhour.................. __?perdevice
Totalidoststs e i el e B o e $30 per device

Assume that the following data appeared in Copland’s records at the end of the past month:

fi-\ctual ProguBtion: i iiae il e 96,000 unia

Actiialisalesiiicaia s s Lot 90,000 units
Materials costs (505,000 ounces) .............. $?
Materials prGEVaHanee i . os o oo, 63,000 U
Materials efficiency variance................... 70,000 U
Direct labor price variance .................... 18,7500 1F
Direct |abor (87.500ih@Ues): i wot 2 i [Link] 918,750
Qverapplied pverieod ot ... ............... 25,200 )

There are no materials inventories.

Required
a. Prepare a variance analysis for direct materials and direct labor.
b. Assume that all production overhead is fixed and that the $27,000 underapplied is the only
overhead variance that can be computed. What are the actual and applied overhead amounts?
c. Complete the standard cost sheet.
(CPA adapted)

16-74. Variance Computations with Missing Data (LO 16-5, 6)

Anthon Corporation has provided the following information regarding last month’s activities. .

G\its producedif@ctlial): o s . 10,5&

Master production budget
Birectmaterials, . Ll s $237,600
BDirectdaBopt CoEt ki b g D 201,600
©verheadipt Gar b, h i 267,000
Standard costs per unit
Biteckmatetials " 1o $3.96 per liter x 5 liters per unit of output
Birectdabor: -« UL oo G Eang e $33.60 per hour x 0.5 hour per unit
Vaniableeverhead .. ... .5 L $28.50 per direct labor-hour
Actual costs
Direct materials purchased and used. . . $207,480 (53,200 liters)
Bifectdaops ey mrtii Sk SHE i TG 176,472 (5,160 hours)
\ Overheadi il 5ot Do o el 272,000 (58% is variabie)

Variable overhead is applied on the basis of direct labor-hours.

776 Part IV Management Control Systems

(LO 16-5,6) 16-75. Comprehensive Variance Problem

Robinwood Fixtures manufactures two products, K4 and X7. The company prepares its master .
budget on the basis of standard costs. The following data are for September:

f K4 X7

Standards
BieGlmatetialsy | G s 0.75 pound at $6.00 per pound 1 pound at $6.60 per pound
BIEchlahorsy s i ool e Te 1.25 hours at $24 per hour 1.5 hours at $30 per hour
Variable overhead (per direct labor-hour) . . . . $19.20 $21.00 |
Fixed overhead (per month)................ $402,408 $477,360
Expected activity (direct labor-hours)........ 17,250 23,400
Actual results
Direct materials (purchased and used). . ..... 9,300 pounds at $5.40 per pound 14,100 pounds at $6.90 per pound
Biiecklabor = v e s nh i 14,700 hours at $24.30 per hour 22,200 hours at $30.60 per hour
Waligblaioverheatls & i row s oiom $291,060 $454,212
EIREdIVereadt s ot e $376,740 $475,200
Unitsiproduced (@ctual)s .o v v foiaie iy 12,000 units 14,400 uniisfig

Required
a. Prepare a variance analysis for each variable cost for each product.
b. Prepare a fixed overhead variance analysis for each product like the one in Exhibit 16.17.

(LO 16-7) 16-76. (Appendix) Recording Costs in a Standard Costing System

Refer to the information in Problem 16-75. Assume that the company carries no beginning or end-
ing inventories. Sales in March totaled $3,800,000 for both products combined. ‘
Required
Prepare the journal entries to record the activity for the last month using standard costing. Assume
that all variances are closed to Cost of Goods Sold at the end of the month.

(LO 16-5,6) 16-77. Variance Analysis with Missing Data

The following information concerning actual results is available from Hamburg, Inc.:

,,,,,

[ Saled Volitne - ETEg v Rt B luolion sl d 72,000 units

SalesireVenlie & & b S i $756,850
Variable costs:
Manufactlringsa i b e sinin i o 198,520
Marketing and administrative................ 127,900
Fixed costs:
Manutactlfngie. i s v e w e 202,750
Marketing and administrative............... 62,440
. Operating profit $165,240

The company planned to sell 64,800 units at a price of $11 each. Variable marketing and
administrative costs are budgeted at 15 percent of revenue. You have discovered that the manu-
facturing fixed costs are budgeted to be $3 per unit at the budgeted volume. You know that the
company policy is to budget for an operating profit of $2.55 per unit. Finally, you recall that the
master budget for fixed marketing and administrative costs is $64,800. Hamburg does not carry
any inventories.

Required ‘
Prepare a report explaining the differences between the actual results, flexible budget, and the
master budget.
 Chapter 16 Fundamentals of Variance Analysis 777

16-78. Profit Variance Analysis

(L0 16-2,3,4)
‘ Harlow Parts produces a single product at its Superior Plant. The master budget for J uly follows:

y A | B
1 Harlow Parts
2 Superior Plant
i Master Budget
4 (For July)
5
6 Quantity 8,000
7
8 |Revenue $ 1,520,000
9 | Variable manufacturing cost 576,000
10; Variable SG&A cost i 96,000
11 Contribution margin $ 848,000
12 Fixed manufacturing cost 192,000
13 Fixed SG&A cost 350,000
14 |Operating profit $ 306,000
15

The following operating income statement shows the actual results for July:

A A | B
1 Harlow Parts
‘ 2 Superior Plant
3 Operating Results |
4 (For July) &
5 |
6 Quantity (units) 9,400
7z
8 Revenue $ 1,710,800
9 Variable manufacturing cost 700,394
10 Variable SG&A cost 109,040
11 Contribution margin $ 901,366
12 Fixed manufacturing cost 203,040
13 |Fixed SG&A cost 360,000
14 |Operating profit $ ' 338,326
15

Required
Prepare a profit variance analysis for the Superior Plant for July such as the one in Exhibit 16.5.

16-79. Production Cost Variance Analysis (LO 16-5, 6)

Refer to the information in Problem 16-78. Variable overhead is applied on the basis of machine-
hours. The standard cost sheet follows:

Standard production costs |

Direct materials 5.00kg. @ $6.00 $ 30.00
Direct labor 0.50 dih @ 30.00 15.00
Variable overhead 0.75 mh** @ 36.00 27.00
Fixed overhead 0.50 dh @ 48.00 24.00
‘ Total unit cost $ 96.00

*Direct labor-hours
** Machine-hours
 Part IV Management Control Systems

The actual resource usage for July per unit of output follows:

Actual production costs

Direct materials
Direct labor
Variable overhead
Fixed overhead
Total unit cost

*Direct labor-hours
| ** Machine-hours

Required
Prepare a manufacturing cost variance analysis for the Superior Plant for July such as those in
Exhibits 16.10, 11, 12, and 17.

(LO 16-2,3,4) 16-80. Profit Variances—Analysis and Visualization

Refer to the information and analysis of Problem 16-78.

Required
Help the managers at Harlow understand the implications from the profit variance analysis by writ-
ing a short summary of your analysis. Include visualizations to highlight your conclusions.

(LO 16-5, 6) 16-81. Production Cost Variances—Analysis and Visualization

Refer to the information and analysis of Problem 16-79.

Required
Help the managers at Harlow understand the implications from the production cost variance analysis
by writing a short summary of your analysis. Include visualizations to highlight your conclusions.

INTEGRATIVE CASES
(LO 16-2) 16-82. Ethics and Efficiencies
Keewee Company manufactures a single product for the military. Keewee Company had steady
work, but it only had a return on investment of 6 percent.
The CEO of Keewee Company did a test flight of Keewee’s product and subsequently had
a heart attack and died. The board of directors hired a new CEO of the company. The board of
directors had been disappointed for many years at the meager 6 percent rate of return. The board
of directors offered the new CEO a substantial bonus if he raised the return on investment to 10
percent.
The new CEO went about his task of raising the return on investment. It turned out to
be easier than he ever imagined. By installing a new standard cost system, he substantially
improved efficiencies in the operations of the company. He made remarkable progress in turn-
ing the company around. In fact, the new CEO anticipated a return on investment of 15 percent
for the year.
This created a dilemma for the new CEO. The board had promised a bonus if he reached the
10 percent threshold, but no additional bonus if he exceeded the 10 percent threshold. He discov-
ered that if he deferred some revenue until next year, and prepaid some of next year’s expenses, he
would achieve a return on investment of 11 percent. (The company should have debited a prepaid
expenses account, but they debited expenses instead.) He justified this action by saying he was
“saving for a rainy day.”
Before the end of the year, he renegotiated his contract with the board of directors, which
specified additional bonuses if he exceeded the 10 percent percent return on investment.

Required
Why would the new CEO want to defer some revenue and prepay some expenses? Is this ethical?
(CMA Adapted)
 Chapter 16 Fundamentals of Variance Analysis 779

16-83. agm-online: Performance Measurement and Variances (LO 16-1,2,3,4,5,6)

I thought the Internet would be an ideal way to distribute our products. We’ve had a lot of success
with our direct sales, but now we can reach a much larger audience. The baskets we make and sell
appeal to people everywhere. I thought about opening stores in other towns or maybe even fran-
chising, but the web offers me a way to expand without losing control.
That’s why the results for the first quarter of our web-based unit are so disappointing. We
expected a small loss because of marketing and other start-up expenses, but I was not prepared for
the beating we took.

Maya McCrum, President and CEO, AGM Enterprises

Organization
AGM Enterprises is a small, family-owned and -managed company that produces and sells wooden
baskets. The company was founded in 1947 in California by Autumn McCrum as a way of supple-
menting the family income. The business remained small until 1990, when Maya McCrum took
it over from her mother. Until that time, all orders were taken by the senior Ms. McCrum and all
baskets were handmade by her. Ten years ago, Maya moved to a model of having “dealers” take
orders and opened a small workshop where part-time labor produced the baskets. The dealers were
also looking to supplement their incomes and, supplied with a small display inventory, displayed
the baskets at home or at parties, and took orders. Order fulfillment was handled directly by AGM
Enterprises personnel, who shipped finished baskets directly to customers. Little production inven-
tory was kept.
Last year, Maya McCrum evaluated the costs and benefits of two alternative distribution chan-
nels in an attempt to expand the business beyond the West Coast. One alternative was to franchise
the business. Maya was concerned that she and the managers of AGM would lose control, espe-
cially control over quality, which she felt distinguished AGM baskets. The other alternative was to
begin taking orders over the Internet. Maya chose the Internet option. The company added a new
managerial position, chief technology officer (CTO), and established a subsidiary, agm-online, to
handle the new business. In an unusual move for the company, Maya went outside the small circle
of family and friends and hired as the CTO Mary Brown, who had experience on both the techni-
cal and management sides of a local Internet start-up. Mary was looking for something new where
she could be in charge of an entire operation and was excited that she could combine this with her
interest in basket weaving. It was agreed that if she could meet or exceed her budget for the first
year of operation, she would be given a substantial piece of agm-online.
The executives of AGM Enterprises considered the initial foray into the Internet to be an
experiment to see if the “anonymous” approach would be effective in selling baskets. Until
this time, AGM considered its network of dealers to be crucial in the growth it had experi-
enced in the last several years. To this end, a separate workshop (factory) was established in
Pennsylvania. One of the reasons for selecting Pennsylvania was the availability of part-time
labor at lower costs than in California. Another was to attempt to penetrate the East Coast
market by locating a workshop there, taking advantage of more immediate access to local
market tastes and trends. It was decided that the Pennsylvania operation would produce exclu-
sively for agm-online business and the California workshop would continue to handle the
orders from dealers.
Most of the staff functions for agm-online were provided and controlled by AGM Enterprises.
Mary Brown and Donna Cunha, the senior vice president of marketing for the parent company,
jointly decided the marketing budget. While the budget was decided jointly, media decisions and
advertising campaigns were run directly from the parent organization. Personnel and financial
services were also centralized.
Mary contracted with a major telecommunications company to provide web hosting services
for the operation. She wanted to go with a telecommunications company rather than a local Internet
service provider (ISP) for reasons of reliability. The back office operations (billing, payroll, etc.)
would be maintained on personal computers at the agm-online office.
780 Part IV Management Control Systems

Exhibit 16.20 $25.00

[Link]. - [Link] i i
Standard Cost Materials
Sheet—agm-online Reed (pounds per unit). ......... 0.4pound@$5 $2.00
Handle. ... . . ..o 0. 410 $6.10
Directlgborsii b e Sl w0 0.5 hour @ $12 6.00
Variable overhead ... ..t i 0.5 hour @ $1 0.50
Fixedoverhead .................. 2.00
Total standardicost s 2:5iq i oiit 14.60

Standard gross profit per unit ..... $10.40

The cost accounting system at AGM Enterprises and the one adopted for agm-online is a
full absorption, standard cost system. Overhead is assigned to products (at standard cost) and not
recognized in income until the product is sold. Variable overhead is allocated on the basis of direct
labor-hours and fixed overhead on the number of units. The fixed overhead rate is based on an
estimated production level for the quarter. All variances from standard are recognized in the period
recorded.
Because of the uncertainty surrounding the demand for baskets using this new channel, the
first-quarter budget was designed to be “easy” to meet. In addition, relatively large marketing
expenses were budgeted for promoting the new channel at related websites and in craft publica-
tions. This was especially important in some of the East Coast publications because AGM had a
small share in these markets. The first-quarter operating budget is shown in Exhibit 16.21. The
marketing and administration budget included the costs incurred by the parent for providing these
services, as well as the cost of the small staff assisting Mary Brown and Jeff Lancaster, the produc-
tion manager at agm-online.

First-Quarter Results
At first, things went well for agm-online. Sales in July were sufficiently strong that managers
thought the initial sales forecast might have been too limiting. Beginning in mid-August, however,
events turned against the new operation. Workers at the telecommunications company went on
strike. At first, there was little impact. On August 9, however, a phone line leading to the server
was damaged. Because of the strike, the site went off the air. It was one week before supervisors
were able to get the site back up. Although difficult to estimate, Mary suggested in a message to
AGM Enterprises that the company lost about 5 percent in unit sales (i.e., about 400 baskets). She
based this estimate on the fact that lines were down 7 days of the quarter (about 7.7 percent) but
that some of the customers that were not able to connect would return when service was restored.
Others would simply click on the next site their search engine identified.
In order to try and counteract some of the negative publicity that had occurred, agm-
online offered some concessions to customers. One concession was free shipping on all orders over
$100. (Initially, shipping was billed to the customer at cost.) This added $13,000 to the Marketing
and Administration expenses for the quarter. Also, at Mary’s request, additional marketing cam-
paigns costing $32,000 were launched in craft magazines and on cable television. These efforts
helped make up for the lost sales.

Exhibit 16.21
Budgeted sales and production. ............... 8,000 baskets
Operating Budget, First
Quarter—agm-online Revenle. - . hiidic vinie s i il s $200,000
Variable costs
Materflals - ;. .0 0 i $48,800
kabor. = ¢ .. i e 48,000
Variableoverhead. .. .............c........ 4,000 100,800
Budgeted contribution margin ................ $ 99,200
Fixedoverhead - . ¢\ . . o .o 16,000
Budgetedigrossimiofity o il i $ 83,200
Marketing and administration ................. 90,000
Operating profit{loss)... .. ... .ic o 0L, $ (6,800)
 Chapter 16 Fundamentals of Variance Analysis 781

As sales were falling, the company was also hit by the booming economy in the state when the
basket makers were finding better part-time employment in the local industries. As a result, agm-
online had to increase the wage rate simply to maintain production.
Not all the news was bad, however. Mary had immediately identified a modification in the
production process at the Pennsylvania workshop that reduced the scrap on each basket by 20 per-
cent. This modification was used on all baskets produced in the quarter. (In the original process,
scrap occurred in the initial cutting of the material and, therefore, no labor was lost because of the
scrap.) In addition, she maintained the level of quality, so the company received no returns and
many comments about future purchases. Still, she was concerned that this poor first-quarter show-
ing was going to be difficult to make up.

I came here because I wanted to work at a company that, first, I had a significant owner-
ship stake in and, second, would allow me to pursue my interest in the craft of basket
weaving full time. I'm afraid that, because of the strike, I won’t meet the first-year budget
and will lose my bonus shares. I think Maya is a fair person, but she has to answer to the
other owners. They might not be so willing to assume that these results are because of
events out of my control.

Exhibit 16.22 shows the actual results for the quarter. The actual direct (materials and labor)
production inputs are shown in Exhibit 16.23. Actual total variable overhead for the quarter was
$5,760 and actual fixed overhead was $16,000.
Next Steps
As Maya contemplates the future of the new distribution channel, she is concerned as well about
the effect of the first quarter on her agreement with Mary.
I would really like the answer to just one question: Should we rewrite our agreement?
From what I have seen, Mary is really dedicated to the business. On the other hand, an
agreement is an agreement. If we revise it now, what kind of problems will we have in the
future?

Required
a. What were the factors that caused actual quarterly income to be less than budgeted? Quantify
the effect of each of these factors. Be as specific as possible.
b. For which of these factors, if any, should Mary be held responsible?
c. Should Maya rewrite the agreement with Mary?

(Copyright © William N. Lanen, 2023)

Exhibit 16.22
Actual sales and production ......... 8,000
Actual Results, First
Revenlle .. ., o = $176,000 Quarter—agme-online
Standard cost of goods sold . ........ 116,800
Grossprofit:. ... .. oL $ 59,200
Production cost variances ........... 12,960
Marketing and administration ........ 135,000
Operating profit (I0SS). .. ............ $ (88,760)

Exhibit 16.23
Input Quantity Total Actual Cost
Actual Direct Production
Materials?® : Quantities and
Reed ' "~ ... .. 2,400 pounds $11,520 Costs—agm-online
Handle. ... «.= 8,000 handles 31,200
Direct labor ... .. 4,800 hours 65,280
782 Part IV Management Control Systems

SOLUTIONS TO SELF-STUDY QUESTIONS .

12

Flexible Budget?® Sales Activity Master Budget

(based on actual Variance (based (based on
activity of on variance in planned activity
110,000 units) sales volume) of 100,000 units)

Salesnlis v h e 110,000 10,000 F 100,000

Sales vl e saantn CIERHAL ML e $1,100,000 $100,000 F $1,000,000
Less costs
Variable costs
Variable manufacturing costs (at $3.80 per unit). .. .. 418,000 38,000 U 380,000
Variable selling and administrative (at $0.90 per unit) 99,000 9,000 U 90,000

foilaHablelcasIs . sl i iin $ 517,000 $ 47,000 U $ 470,000

CONHBUtONMArgin. ... ... .+t b sloibaie sl by $ 583,000 $ 53,000 F $ 530,000
Fixed costs
Fixed manufacturingoverhead .................... 200,000 0 200,000
Fixed selling and administrative costs . ............. 140,000 0 140,000

fofalifixedicosts . 1o e Haw i Banas s o $ 340,000 0 $ 340,000

Profit $ 243,000 $ 53,000 F $ 190,000
P R R R R AR

2 Calculations for flexible budget:

$1,100,000 = (110,000 + 100,000) x $1,000,000
$418,000 = (110,000 + 100,000) x $380,000 ‘
$99,000 = (110,000 + 100,000) x $90,000
U = Unfavorable variance
F = Favorable variance

(1) () @)
Flexible
Actual Inputs at Production
Actual Standard Price Budget

(AP X AQ) Price Variance (SP x AQ) Efficiency Variance (SP x SQ)

$455,000 i ‘
Direct $455,000 — $487,500
Materials T = $32500F '
b " Chapter 16 Fundamentals of Variance Analysis 783

3 The fixed oyerhead rate is $4 per unit (= $320,000 + 80,000 cases).

; Applied
4 : : (based on actual
5 production of
Actual Budget 100,000 cases)