978-1337119207 Chapter 22 Part 2

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Chapter 22(8) Evaluating Variances from Standard Costs 409

SUGGESTED APPROACH—Nonmanufacturing Businesses

Standards can be applied to nonmanufacturing businesses, provided that they use repetitive activities to

produce a common product or service. For example, businesses that specialize in fast, no-appointment-

needed oil changes provide a standard service comprised of repetitive activities. A standard cost to

perform an oil change could be developed based on the (1) standard labor time to change a customer’s oil,

(2) standard wage rate, (3) standard quantity of supplies used (motor oil, filters, etc.), and (4) standard

price of supplies.

Public accounting firms are another example of businesses that rely heavily upon standards. Budgets and

standards are used to measure performance on various client engagements, such as audits and tax work.

WRITING EXERCISE—Standards in a Nonmanufacturing Environment

Ask your students to answer the following in writing [TM 22(8)-8].

Describe a nonmanufacturing business that could benefit from the use of standards. Also

explain how standards would help that business control its operations.

Possible response: One example of a business that could benefit from the use of standards in a

nonmanufacturing environment would be medical or legal transcription. The number of words

transcribed per minute is an easy measurement to determine how employees are performing

OBJECTIVE 4

Compute and interpret factory overhead controllable and volume variances.

SYNOPSIS

The factory overhead costs are analyzed differently than materials and labor due to fixed and variable

components. Factory overhead is first separated to allow its components to be analyzed. The factory

factory overhead controllable variance = actual variable factory overhead – budgeted variable factory

overhead. The budgeted variable overhead is computed as: budgeted variable factory overhead = standard

hours for actual units produced × variable factory overhead rate. The variable factory controllable

variance is computed as: variable factory overhead controllable variance = actual variable factory

Chapter 22(8) Evaluating Variances from Standard Costs 410

hours for 100% of normal capacity – standard hours for actual units produced) × fixed factory overhead

rate. The volume variance measures the use of fixed overhead resources. Management should determine

overhead. If the actual factory overhead exceeds the budgeted factory overhead, the controllable variance

is unfavorable. If the actual factory overhead is less than the budgeted factory overhead, the volume

variance is unfavorable.

Key Terms and Definitions

produced.

 Controllable Variance—The difference between the actual amounts of variable factory overhead

cost incurred and the amount of variable factory overhead budgeted for the standard product.

 Factory Overhead Cost Variance Report—Reports budgeted and actual costs for variable and

fixed factory overhead along with the related controllable and volume variances.

Relevant Check Up Corner and Exhibits

 Exhibit 8—Factory Overhead Cost Budget Indicating Standard Factory Overhead Rate

 Exhibit 9—Graph of Fixed Overhead Volume Variance

 Exhibit 10—Factory Overhead Cost Variance Report

 Exhibit 11—Factory Overhead Variances

SUGGESTED APPROACH

Consider spending extra time covering factory overhead variances, since students seem to have the most

difficulty with these variances. One of the major reasons for this is that, while direct materials and direct

labor costs are variable, factory overhead costs have both fixed and variable components. You can

continue the pattern of demonstrating variance calculations and asking students to practice these

computations, using the aids below.

DEMONSTRATION PROBLEM—Overhead Variances

rate, calculated as follows:

Estimated Total Factory Overhead Costs

Estimated Activity Base (or Driver) (e.g., direct labor or machine hours)

Chapter 22(8) Evaluating Variances from Standard Costs 411

Factory overhead variances result when factory overhead applied to products does not equal actual

overhead. Therefore, factory overhead variances occur whenever:

1. Factory overhead costs were greater or less than estimated.

2. The company operated above or below the capacity anticipated when estimating the activity driver.

Use the following data to illustrate factory overhead variances.

Martin Manufacturing applies factory overhead to products using direct labor hours. To calculate a

predetermined overhead rate, Martin developed the following estimates for one month of production.

Direct labor hours at 100 percent of normal capacity 12,000 hrs.

Estimated fixed factory overhead costs $120,000

Estimated variable factory overhead costs at 100 percent of normal capacity $ 84,000

As a result, Martin’s predetermined factory overhead rate is $17 per direct labor hour. Of that rate, fixed

factory overhead is $10 per hour ($120,000/12,000 hrs.) and variable factory overhead is $7 per hour

($84,000/12,000 hrs.).

Martin’s labor standards allow 0.5 direct labor hours for each unit produced. During November, 20,000

units were produced. Actual fixed factory overhead costs were $120,000. Actual variable factory

overhead costs were $88,000.

Variable Factory Overhead Controllable Variance: The text defines this variance as the difference

between actual variable overhead costs and variable overhead budgeted for the amount of product actually

produced. (Note that the text is essentially presenting a two-way overhead analysis.) This can be

expressed in the following formula:

Actual Var. OH – (Var. OH Rate per Hr.  Units Produced  Standard Hrs. per Unit)

Using data from Martin Manufacturing:

Actual Variable Factory Overhead = $88,000

Budgeted Variable Factory Overhead for

Actual Amount Produced = $7  20,000 units  0.50 hrs. per unit = $70,000

Controllable Variance = $88,000 – $70,000 = $18,000 unfavorable

Fixed Factory Overhead Volume Variance: This variance measures the difference between the budgeted

fixed overhead at 100 percent of normal capacity and the standard fixed overhead for the amount of

product actually produced. In essence, it measures the impact of spreading fixed overhead over the wrong

number of units, whenever actual production does not equal the amount anticipated by the predetermined

fixed overhead rate. This can be expressed in the following formula:

(Hrs. at 100% of normal capacity – Std. Hrs. for Actual Production)  Fixed OH Rate per Hr.

Chapter 22(8) Evaluating Variances from Standard Costs 412

Remind students that the term “Hrs. at 100% of normal capacity” is the hours used in computing the

predetermined overhead rate.

Using the data from Martin Manufacturing:

(12,000 hours – 10,000 hours)  $10 per hr. = $20,000 unfavorable

Therefore, Martin’s total overhead variance is as follows:

Controllable variance $ 18,000 unfavorable

Volume variance 20,000 unfavorable

Total overhead variance $ 38,000 unfavorable

Emphasize that the total factory overhead variance is also the difference between actual overhead costs

GROUP LEARNING ACTIVITY—Overhead Variances

TM 22(8)-5 presents data for your students to use in calculating overhead variances. The solution to the

exercise is provided on TM 22(8)-6.

OBJECTIVE 5

Describe and illustrate the recording and reporting of standards and variances.

SYNOPSIS

depending on whether the amount requested was above or below the standard, and Materials would be

credited. A debit balance in the direct materials quantity variance account represents an unfavorable

variance. The direct labor entries are summarized as: Work in Process is debited, Wages Payable is

credited for the actual direct labor cost, Direct Labor Rate Variance is debited for an unfavorable variance

Chapter 22(8) Evaluating Variances from Standard Costs 413

Relevant Check Up Corner and Exhibits

 Exhibit 12—Variance from Standards in Income Statement

SUGGESTED APPROACH

Some companies choose to integrate standards and variances into their accounting records. When this

occurs, entries to the materials, work in process, and finished goods inventory accounts are recorded at

standard, not actual, costs. It is helpful to illustrate these entries for your students. A demonstration

problem is included below for that purpose.

DEMONSTRATION PROBLEM—Journal Entries at Standard

Purchase of Materials: Brass Works used 1,050 pounds of direct materials that cost $5.40 per pound. The

effect of paying $0.40 more per pound than standard was a $420 unfavorable price variance. The purchase

of these materials would be recorded as follows:

Materials (1,050 pounds  $5.00) 5,250

Direct Materials Price Variance 420

Accounts Payable (1,050 pounds  $5.40) 5,670

Requisition of Materials: Brass Works used 1,050 pounds of direct materials for production when the

standard materials quantity was only 1,000 pounds. The effect of using more materials than standard is

recorded when the materials are transferred to Work in Process.

Work in Process (1,000 pounds  $5.00) 5,000

Direct Materials Quantity Variance 250

Materials (1,050 pounds  $5.00) 5,250

amount of materials still on hand.

Payment of Direct Labor Costs: Brass Works incurred 2,380 direct labor hours at a cost of $9 per hour.

The standard was 2,000 hours at $10 per hour. The payroll entry to record direct labor wages is:

Work in Process (2,000 hours  $10) 20,000

Direct Labor Time Variance 3,800

Direct Labor Rate Variance 2,380

Chapter 22(8) Evaluating Variances from Standard Costs 414

Wages Payable 21,420

The work in process account is debited for the standard labor rate and standard labor time.

Remind students that variances are usually transferred to Cost of Goods Sold at the end of the year.

management use. Exhibit 12 in the text provides an example of an income statement that reports

variances. The key to this exhibit is understanding how the variances affect gross profit. Use the chart on

TM 22(8)-7 to explain the impact of favorable and unfavorable variances on gross profit.

OBJECTIVE 6

SYNOPSIS

A nonfinancial performance measure expresses performance in a measure other than dollars. Using

financial and nonfinancial performance measures aids managers and employees in considering multiple

performance objectives. Examples of nonfinancial performance measures are listed in Exhibit 13.

Nonfinancial measures are often linked to either the inputs or outputs of an activity or process. A process

Key Terms and Definitions

 Nonfinancial Performance Measure—A performance measure expressed in units rather than

dollars.

 Process—A sequence of activities linked together for performing a particular task.

Relevant Check Up Corner and Exhibits

 Exhibit 13—Nonfinancial Performance Measures

Chapter 22(8) Evaluating Variances from Standard Costs 415

SUGGESTED APPROACH

WRITING EXERCISE—Nonfinancial Performance Measures

Ask your students to write their opinion on the following questions [TM 22(8)-9]:

Students’ scores on exams may be equated to financial measures used to evaluate

employee performance in a business. Should college professors limit their evaluation of

Possible response: Professors use optional measures to evaluate students all the time. Attendance,

extra credit, and the subjective nature of some assignments provide options for evaluation on

course work other than exam scores. Benefits include motivating students to put in extra time and

effort to grasp the subject. In academia as in business, financial measures are not always the final

or only performance measure.

CLASS DISCUSSION—Nonfinancial Performance Measures

ADM OBJECTIVE

Describe and illustrate the use of the direct labor time variance in evaluating staff

performance in a service setting.

SYNOPSIS

are repetitive in nature.

Relevant Check Up Corner and Exhibits

 Make a Decision – Service Staffing Variances

Type Item Description Video Excel CLGL LO(s) Difficulty Time Est BUSPROG AICPA

ACBSP – Primary Bloom’s ADM Service Real World

Writing

Ethics

MC 1 3 Easy 5 min. Analytic FN – Measurement Budgeting and Responsibility Applying

MC 2 3 Easy 5 min. Analytic FN – Measurement Budgeting and Responsibility Applying

MC 3 4 Easy 5 min. Analytic FN – Measurement Budgeting and Responsibility Applying

MC 4 4 Easy 5 min. Analytic FN – Measurement Budgeting and Responsibility Applying

MC 5 4 Easy 5 min. Analytic FN – Measurement Budgeting and Responsibility Applying

LREX 1 Direct materials variances x 3 Easy 10 min. Analytic FN – Measurement Budgeting and Responsibility Applying

LREX 2 Direct labor variances x 3 Easy 10 min. Analytic FN – Measurement Budgeting and Responsibility Applying

LREX 3 Factory overhead controllable variance x 4 Easy 5 min. Analytic FN – Measurement Budgeting and Responsibility Applying

LREX 4 Factory overhead volume variance x 4 Easy 5 min. Analytic FN – Measurement Budgeting and Responsibility Applying

LREX 5 Standard cost journal entries x 5 Easy 5 min. Analytic FN – Measurement Budgeting and Responsibility Applying

LREX 6 Income statement with variances x 5 Easy 15 min. Analytic FN – Measurement Budgeting and Responsibility Applying

Focus

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