Section B - Performance Management CMA Part 1 Section B - Performance Management Performance Management represents 25% of the CMA Part 1 exam. Part 1 is a four hour exam that will contain 100 multiple-choice questions and 2 essay questions. Topics within an examination part and the subject areas within topics may be combined in individual questions. Therefore, we cannot predict how many multiple choice questions you may get from this section, nor can we predict whether you will get any essay questions from this section. The best approach to preparing for this exam is to know and understand the concepts well and be ready for anything. Mathematically, the majority of the questions will come from variance analysis and performance measurement parts of this section. A number of variances are covered, and you need to know not only how to calculate them, but also what they mean and who can affect them. While the variance topic may seem large and overwhelming at first, when it is broken down into its individual elements it will become easier. The performance measurement portions focus on a few performance measures, specifically Return on Investment (ROI) and Residual Income (RI). For these measurements you need to know what they are, how they are calculated and how they are used. You also need to be able to identify the weaknesses that are inherent in each one. In addition to these topics, there are a few other larger topics in this section. Responsibility accounting is the breaking down of costs into those costs that can be controlled by the manager and those that cannot be controlled by the manager. There are a number of different cost classifications and allocation methods within this section that you need to be aware of. Transfer pricing is a topic that you need to know from both a theoretical standpoint and a numerical one as well. The questions may require you to understand the issues that company faces in establishing the transfer price as well as being able to calculate an acceptable transfer price under certain situations. The final topic covered in this Section is performance feedback, and more specifically the balanced scorecard. You need to know conceptually what the balanced scorecard is and how it works as well as be familiar with its application. 98 Section B Introduction to Variance Analysis and Standard Costs Introduction to Variance Analysis and Standard Costs Variance analysis is the process of comparing the actual expenses and revenues during a certain period to the budgeted amounts for that same period. Through the use of variance analysis, we are able to determine why our actual results were different from the budgeted amounts. This will enable us to focus our efforts on the areas of the operations that have been operating less efficiently than planned. We introduced standard costs in the Budgeting section. Before getting into the process of variance analysis, we need to look them again and the role they play in the accounting and costing system. A standard cost is an estimate of the cost the company expects to incur in the production process. Without a standard cost, the analysis of actual activities and results is very difficult because there is no standard against which to measure the performance. This standard cost is calculated prior to the beginning of each year and it is based on the estimated costs and the expected level of activity or production. As we saw in the Budgeting section, standard costs are determined through the use of accounting and production estimates. They are not simply created by management. The comparison of actual costs to these standard costs allows the company to analyze its actual costs and also enables the company to undertake some forms of controls of the costs. A large variance between the standard cost and the actual cost is an alert to management that something is possibly wrong and needs attention. A standard cost is not the same thing as a standard cost system. A standard cost prescribes expected performance is in terms of cost. A standard cost system is an accounting system that uses standard costs and standard cost variances in the formal accounting system. There are other types of accounting systems, and standard costs can be used with those accounting systems as well. In those other types of accounting systems, the standard costs are used for control purposes outside the formal accounting system. The emphasis in this section, though, will be on standard cost systems. A standard cost system may be used with either a process costing system or a job-order costing system. A process costing system is used to assign costs to individual products when the products are all relatively similar and are mass-produced, as on an assembly line. lob-order costing is a method in which all of the costs associated with a specific job (or client) are accumulated and charged to that job (or client). Reasons for adopting a standard cost system include: • It is usually simpler to use standard costs in a process costing system because of the repetitive nature of the operation. • Use of standard costs in a process cost system make it much easier to determine cost per equivalent unit, because the standard costs serve as the cost per equivalent unit for direct materials, direct la bor, and manufacturing overhead. • Use of standard costs Simplifies record keeping in either a process costing system or a job-order costing system. Records need to be kept only for quantities on hand. The cost associated with those quantities is simply the standard cost for the period. Standard costs are best used with a flexible budgeting system in order to provide the most useful variance analysis. The flexible budget will enable the company to identify differences from the budget that are not simply due to the actual quantity sold being different from the budgeted quantity sold. Note: A flexible budget is a budget that is prepared using the standard costs and the actual level of output. It is essentially what the budget would have been if the company had known the actual level of sales at the start of the year. Flexible budgets are covered in much more detail in Section A of this book. 99 Introduction to Variance Analysis and Standard Costs CMA Part 1 Determining the Level of Activity Costs are the result of activities that are undertaken to create products or render services. Therefore, it is activities, not costs, that managers manage. Thus, standards should be established for the cost drivers underlying the costs. When determining the level of activity or production for the calculation of standard costs, it is important to use the correct level of activity when developing the standards. If the standard level of activity is set too high, there will be no motivation among the workers. This is because they know that no matter how hard they work, they will still fail to meet the budgeted level of output. Ideal, perfect or theoretical level of output assumes that there are no breakdowns, no waste and no time lost to illness, and that the workers are already working at maximum effiCiency. An alternative to this theoretical level of output is the practical, or currently attainable, level of output. This is the level that will be achieved given the normal amount of time lost, normal amount of waste and a normal learning curve for employees. The goal is to use a level that is attainable, but difficult to attain. This will motivate the workers and still require them to work diligently. In practice, however, either the normal level of output or the master budget level of output is used to set the standards. Normal level is an average expected level of production within the time frame of several years (up to three) given the reasonable expectations of effective and efficient production and customer demand. Master budget capacity is the planned capacity for the next budget period. In addition to setting the correct level of output, the standard cost also needs to be reviewed from the perspective of the costs of the inputs into the process, because it will change over time. If the cost of materials goes up or down, the standard cost must also be adjusted. Sources of Standards Appropriate standards are often set by using several sources, including activity analysis, historical data, benchmarking, target costing and strategic decisions. Activity analysis involves identifying, delineating or outlining, and evaluating all the activities necessary to complete a job, a project or an operation. An activity analysis considers everything required to complete the task efficiently and involves personnel from several areas including engineers, management accountants and production workers. Product engineers specify product components. Industrial engineers analyze the steps or procedures necessary to complete the task. Management accountants work with the engineers to complete the analysis. Activity analysis is time consuming and expensive. However, if properly executed, activity analysis is the most precise way to determine standard costs. Use of historical data is a less costly way to develop standard costs. Historical data for a similar product can be a good source for determining the standard cost of an operation, if reliable information is available. Another advantage to using historical data is that it is based on the way the particular firm has operated in the past. This can also be a disadvantage, because a standard based on the past can perpetuate past inefficiencies. Although historical standards are more attainable than ideal standards, they are not consistent with a philosophy of continuous improvement. Benchmarking to develop standard costs is based on current practices of similar operations in other firms. Associations of manufacturers often collect industry information and have data available. The firm can use this data as guidelines for setting standard costs. By using benchmarking to set standard costs, a firm can have access to the best performance anywhere and this can help sustain its competitive edge. A disadvantage of using benchmark data is that it might not be completely applicable to the firms own situation. Use of target costing to set standard costs puts the focus on the market and on the price the product can be sold for. A target price is the price the firm can sell its product for, and the target cost is the cost that must be attained for the firm to realize its desired profit margin for the product. Once the target cost has been determined, detailed standards are then set to attain the desired cost. 100 Section B Introduction to Variance Analysis and Standard Costs Target costing utilizes the concept of kaizen, or continuous improvement, to reduce costs to what is necessary in order to earn the desired profit margin. This takes place through development of new manufacturing methods and techniques, which entails the continuous improvement or ongoing search for new ways to reduce costs. This is the heart of the kaizen concept. Additionally, strategic decisions may affect a products standard cost. For instance, a decision to replace an obsolete machine with a new, computer-controlled machine would require an adjustment to the standard cost for the process. Or a commitment to strive for kaizen will require standards to be set at a level that would provide the maximum challenge. Management by Exception Once standards have been set, and in a system where variances are identified and reported to the appropriate level of the company, management can manage by exception. This means that management can focus time in areas where there are problems, as identified by the fact that there is a variance from the standard. The disadvantage of this method is that negative trends may be overlooked at earlier stages. Also, if too many deviations from the budget occur, this approach can become a very confusing and involved process of trying to fix all of the problems at once. Question 44: Which one of the following is least likely to be involved in establishing standard costs for evaluation purposes? a) Budgetary accountants. b) Industrial engineers. c) Top management. d) Quality control personnel. (CMA Adapted) Question 45: A firm most often uses a standard costing system in conjunction with: a) Management by objectives. b) Target (hurdle) rates of return. c) Participative management programs. d) Flexible budgets. (CMA Adapted) 101 Variance Analysis Concepts CMA Part 1 Variance Analysis Concepts Before looking at the individual variances that are related to the price and usage of labor and materials, we will start by looking at some general variance concepts. Variances, in general, are a comparison between the budgeted results of the company and the actual results of the company. The more detailed levels of variance analysis determine, to a greater extent, the cause for the difference - i.e., whether the actual quantity was different from the budgeted quantity or the actual price per unit was different from the budgeted price, or whether both were different. Because of the nature of variances, all of the calculations we make will be a comparison between an actual amount and a budgeted amount. What we are specifically comparing will depend on the variance that we need to calculate. Note: In this section, the terms budget and standard are used interchangeably and mean the same thing: a planned amount. Static Budget Variances Vs Flexible Budget Variances Recall that a static budget is a fixed budget. It is a budget that is prepared for one specific level of planned activity, and that level of planned activity does not change, no matter what the actual activity is. A static budget is easy to prepare, but it is not very useful for control and evaluation purposes if the actual level of activity is different from what had been planned. For instance, a cost may be higher than budgeted, but if sales were also higher than expected, the portion of the variance that is due to the increased activity is to be expected and is not a cause for concern. A more useful and usable budget is a flexible budget. This is a budgeted amount that is adjusted to the actual level of activity that has occurred. Flexible budget variances are a better indicator of operating performance than static budget variances are, because they compare actual results to the budgeted results for the actual volume. If an actual cost is higher than its flexible budget amount, then that variance may be cause for concern. Static Budget Variances The first variances we will look at are the most global. The total static budget variances simply compare the static (master) budget against the actual results. While these variances tell us whether we performed better or worse than budgeted, they do not provide any information as to why that has happened. Here is an example of a static budget variance report. This report is based upon the income statement. When we move into manufacturing input variances, variance reporting will be concerned with production costs instead of with the income statement. 102 Section B Variance Analysis Concepts Actual IIl1dgllt Bllyltl (1) (2) (3) = (1) - (2) Static Static 1l1[iID1l Budget Units sold 20,000 24,000 4,000- U Revenues $2,500,000 $2,880,000 380,000- U Variable costs Direct materials 1,243,200 1,440,000 196,800- F Direct manufacturing 396,000 384,000 12,000+ U labor Variable manufactur- 261,000 288,000 27,000- F ing overhead Total variable costs 1,900,200 2,1 12,000 21 1,800- F Contribution margin 599,800 768,000 168,200- U Fixed costs 570,000 552,000 18,000+ U Operating income $ 29800 $ 216000 $ 186200- U A favorable variance is a variance that causes actual net operating income to be higher than the budgeted amount. An unfavorable variance is a variance that causes actual net operating income to be lower than the budgeted amount. Therefore, actual revenue that is below budgeted revenue is a negative variance because actual is lower than budget. That is unfavorable because it will cause actual net operating income to be lower than the budgeted amount. On the other hand, actual expenses that are below budgeted expenses are also negative variances, because actual is lower than budget, but they are favorable variances because they will cause actual net operating income to be higher than the budgeted amount. If net operating income is to be increased, you want revenues to be higher than budgeted (a positive variance amount) and you want expenses to be lower than budgeted (a negative variance amount). Both of those are favorable variances. Note: When calculating variances for incomes or expenses, if you always subtract the Budget amount from the Actual Amount (such as in the example above), the sign of the variance will always follow these rules: A positive variance for an income item is a Favorable variance A negative variance for an income item is an Unfavorable variance A positive variance for an expense item is an Unfavorable variance A negative variance for an expense item is a Favorable variance Actual - Budget = Variance 103 Variance Analysis Concepts CMA Part 1 Flexible Budget Variances and Sales Volume Variances Each of the static budget variances can be further broken down into two subvariances - the flexible budget variance and the sales volume variance. The flexible budget variance is the difference between the actual results and the flexible budget. The flexible budget is budgeted amounts that have been adjusted to the actual level of activity that has occurred. The sales volume variance is the difference between the flexible budget amount and the static budget amount. These variances may be calculated at the level of the income statement as a whole and for each individual item within the income statement. Example: Here is our example again, this time showing the static budget variances, the flexible budget variances, and the sales volume variances for each line item and for net operating income. Note that for each line, the flexible budget variance plus the sales volume variance equals the total static budget variance. This is shown for the net operating amounts at the bottom of the report. You should verify the calculation of it for the individual lines, as well, to make sure you understand it. Actual results (1) 20,000 0 20,000 4,000 -U $2,500,000 $100,000 +F $2,400,000 $480,000 -U Flexible budget variances (2)=(1)-(3) Flexible budget (3) Sales volume variances (4)=(3)-(5) Static budget (5) 24,000 $2,880,000 Static Budget Variances (6)=(1)-(5) AL50 (6)=(2)+(4) 4,000 -U 380,000 -U Units sold Revenues Variable costs Direct materials Direct manufacturing labor Variable manufacturing overhead Total variable costs Contribution margin Fixed costs Operating income 1,243,200 396,000 43,200 +U 76,000 +U 1,200,000 240,000 -F 320,000 64,000 -F 1,440,000 384,000 196,800 -F 12,000+U 261.000 1.900.200 599.800 570,000 $ 29800 $ 58200 -U $ 88000 $ 128000 U t Total flexible budget variance t 21.000 +U 140.200 +U 40.200 -U 18.000 +U 240.000 48.000 -F 1.760,000 352,000 -F 640.000 128.000 -U 552.000 o $58,200 U t 288.000 2,112.000 768.000 552.000 $ 216000 $ 186200 U t 27,000 -F 211.800 -F 168.200 -U 18.000+U $128,000 U Total sales volume variance $186,200 U $186,200 U j Total static budget variance 104 Section B Variance Analysis Concepts Note: On the Exam, you may be asked a question about a variance of any component of a budget. For example, you may be asked to calculate the variable costs flexible budget variance. You simply calculate the difference between the actual and the flexible budget amounts of variable costs and determine whether the variance is favorable or unfavorable. If a question does not say what line to use, use either the contribution margin line or the operating income line. If the question is asking for the volume variance, the variances on the contribution margin line and the operating income lines will be exactly the same, so it does not matter which line you use. The reason the variances on these two lines are the same is that the volume variance is the difference between the static budget amount and the flexible budget amount. The only difference between the contribution margin line and the operating income line is fixed costs; and fixed costs are exactly the same in the flexible budget as they are in the static budget. Therefore, the volume variance for the contribution margin line will be exactly the same as the volume variance for the operating income line. As shown on the following pages, we are really most interested in the flexible budget and the flexible budget variances. This is because the sales volume variances are explained simply, by the fact that the actual level of sales was different from the budgeted level of sales. The flexible budget variances, on the other hand, identify variances that are not the result of different-than-expected sales. In fact, a flexible budget variance for a revenue item is called a selling price variance, because it is caused exclusively by differences between the actual selling price and the budgeted selling price. Types of Variances Before looking at the different individual variances in greater detail, we will simply list the different variances that we will study. You need to know how to calculate each of these and understand what they tell us when calculated. Additionally, you also must be able to identify what may cause the different variances. The variances that we will look at are: Manufacturing Input Variances: Direct Materials Variances 1) Price variance 2) Quantity or efficiency variance 2a) Mix variance* 2b) Yield variance* Direct Labor Variance 3) Rate (price) variance 4) Efficiency (quantity) variance 4a) Mix variance* 4b) Yield variance* Factory Overhead Variances 5) Total Variable overhead variance 6) Total Fixed overhead variance Sa) Variable overhead spending variance 5b) Variable overhead efficiency variance 6a) Fixed overhead spending or budget variance 6b) Fixed overhead production-volume variance 105 Manufacturing Input Variances CMA Part 1 Sales Variances: 7) Sales price variance 8) Sales volume variance 8a) Quantity variance** 8b) Mix variance** These speCific manufacturing variances are calculated only when there is more than one input (either * classes of labor or types of material) into the final product. ** These specific sales variances are calculated when the company sells more than one product. Manufacturing Input Variances Manufacturing input variances are a special class of variances, including direct materials, direct labor, and manufacturing overhead used in production. These variances are concerned with inputs to the manufacturing process and whether the amount of inputs used per unit manufactured was over or under the standard or whether they cost more or less per unit than the standard, and what the cost impact was of each type of variance. Manufacturing input variances are used in controlling production. In the accounting system, manufacturing input variances are closed out at the end of each period to cost of sales or, if material, they are prorated among cost of sales and inventories. A variance report like the one you see above will not reflect the exact manufacturing input variances, because the variance report above reflects sold units, not manufactured units. The input cost variances for the sold units are included in the flexible budget variance amount on the above report, because they are included in the Actual Results column which is compared with the Flexible Budget column to calculate a Flexible Budget variance. However, the detail is not there, and they should not be expected to reconcile with a production variance report. A production variance report includes all units produced, whether they were sold or whether they remained in inventory as unsold units at the end of the period. Before getting into the specific manufacturing input variances, let us think for a moment about the possible reasons for an actual input cost to be different from the standard (i.e., expected or budgeted) cost. The standard cost is determined using an estimated cost and an estimated level of usage. It is obvious that if the company either pays a different price than had been budgeted, or uses a different amount than was budgeted for the actual output, the actual cost for the actual output will be different from the budgeted cost for the actual output. The simple fact that the actual cost is different from the budgeted amount is not, by itself, useful enough for management. Management needs to know why the actual cost is different. Is it because a different amount of raw materials or labor was used than should have been used for the actual output or was it because a different price was paid for the raw materials or labor? Or was it both? The process of variance analysis will enable management to separate out the specific reason(s) for the variance and then focus its efforts on the areas that have a negative impact on the business - identified by unfavorable variances. In variance analYSiS, we subdivide input cost variances into 1) a price variance that reflects the difference between actual and budgeted input prices and 2) a quantity variance, called an efficiency variance, that reflects the difference between actual and budgeted input quantities used. If you are able to keep this simple, conceptual understanding of how variances occur, you should find variance analysis questions a little easier. 106 Section B Manufacturing Input Variances Summary of Manufacturing Input Variances The following table summarizes the calculations that we make and the different terms that we use in variance analysis. We will look at all of these in more detail later, and this table is again presented at the end of the section on variances. We have simply included this table at the beginning to help you see what will be covered. Prime Costs Materials Price Variance Quantity Variance Labor Rate Variance � Multiple Inputs Mix Variance Yield Variance (both Material and Labor) (WASPAM - WASPSM) x AQ (AQ - SQ) x WASPSM Price Variance Quantity Variance (AP - SP) x AQ (AQ - sQ) x SP Efficiency Variance \ Variable Overhead Spending Variance Efficiency Variance Fixed Overhead Spending (Budget) Variance Production Volume Variance (AP - SP) x AQ (AQ - SQ) x SP Actual OH - Budgeted OH Budgeted OH - Applied OH 107 Manufacturing Input Variances CMA Part 1 Direct Materials Variances We will start by looking at the variances related to direct materials and their usage. The total material variance (also called the flexible budget variance) is an easy one to calculate. It is the difference between the actual direct materials costs for the period and the standard costs for the standard amount of materials at the standard price per unit for the level of output actually produced (the flexible budget). Example: Paterno Co. produces footballs. Each football requires a standard of 1 square meter of leather that has a standard cost of $5. During the period, Paterno produced 250 footballs and used 290 meters of leather. The cost of the leather was $4.50 per meter. Therefore, the actual total cost of the leather was $1,305. However, given the actual output of 250 footballs, Paterno should have used only 250 meters. And since each meter should have cost $5, Paterno should have spent $1,250 on leather in order to produce 250 footballs. The total materials variance is: Actual cost - 290 meters x $4.50 Standard cost - 250 meters x $5 Total variance In total, we can see that Paterno spent more money than it should have for the leather to make the footballs. If a manager simply looks at this total variance, the conclusion may be that things are acceptable (it is an unfavorable variance, but it is not that large) and dont require any significant attention. But, when we look in more depth at this example, it is obvious to us that the company used more materials than it should have, but paid less for each square meter of leather than expected. Management will most certainly look at the production process to find out why so much leather was required to make the 250 footballs. Even though Paternos total actual cost came close to the total standard cost, there is a significant problem with production. The company either has a very inefficient process that wastes too much leather, or perhaps it has new workers that are not as experienced as they will be in the future. In either case, despite the fact that the total variance cost was close, Paterno needs to investigate further its usage of leather. Because of the need to have this more useful analysis, the total materials variance is divided into two components - price and quantity. The price variance measures how much of the total variance was caused by paying a different amount for the material than had been budgeted, and the quantity variance (also called the efficiency or usage variance) measures how much of the variance is due to using more or less of the material than budgeted. The Quantity Variance The quantity variance (also called the efficiency or usage variance) is calculated as: $ 1,305 $ 1.250 $ 55 U (Actual Quantity - Standard Quantity for Actual Output) x Standard Price or (AQ - SQ) x SP This is simply the difference between the actual material usage and the standard usage for this level of output, multiplied by the standard price. We use the standard price because we are trying to determine what the variance actually is, because we used either too much or too little material, not how much we paid for it. A positive variance is an unfavorable variance, while a negative variance is a favorable variance. In the example above, the quantity variance is calculated as: (290 - 250) x $5 = $200 108 Section B Manufacturing Input Variances This is an unfavorable variance because if the actual price had been the same as the standard price, Paterno would have had to pay $200 more for the materials it used than it should have, given the number of footballs produced, because it used too much material. The fact that it is unfavorable is indicated by the fact that the number we have calculated is positive. A positive variance for a cost indicates an unfavorable variance, while a negative variance for a cost indicates a favorable variance. The Price Variance The price variance is calculated as: (Actual Price - Standard Price) x Actual Quantity or (AP - SP) x AQ This measures how much of the variance was due to a difference in the price between what we expected it to be per unit and what it the price paid actually was. In the example above, the price variance is calculated as: ($4.50 - $5) x 290 = $(145) This means that we saved $145 because the price of the leather was lower than expected. This is a favorable variance. Remember that a negative variance for a cost is a favorable variance because it means that actual cost was lower than budgeted cost. So even though Paterno used more leather than it should have for each football it manufactured, it saved $.50 per meter because the price was lower than expected. If we take these two variances and add them together, we will have the total materials variance that we first calculated. Quantity variance Price variance Total Variance In total, Paterno had a positive variance of $55, which is unfavorable, because the cost for the extra leather that was used was more than the savings on each meter of leather. Purchase Price Variance If an Exam question asks for the purchase price variance, you calculate this using all of the units purchased, not just the units that are put into production. You need to be certain to notice this word if it is used, since it changes your calculation. One way of looking at these two price variances is as follows: the price variance is calculated at the time of usage, while the purchase price variance is calculated at the time of purchase. Likewise, if a question says that the company recognizes variances as early as possible, you would use the quantity purchased instead of the quantity used. Most questions ask for the price variance as calculated above, using the units placed into production. But be aware of these possible variations. Note: On the Exam, you will need to identify possible reasons why a particular variance is favorable or unfavorable. You should usually be able to do this by common sense. For example, an unfavorable quantity variance may be caused by the purchasing department because it bought an inferior product that was damaged or broken, or because of new employees or poor techniques. In the example above, the variances could be due to the purchasing department getting a good price on inferior leather that was damaged in the production process, or was not always of an acceptable quality. $ 200 U (145) F � U 109 Manufacturing Input Variances CMA Part 1 Accounting for Direct Materials Variances in a Standard Cost System Standard costing systems use actual variance accounts to record the variances from the standard costs as they occur. At the end of the period, the variances are closed out to cost of goods sold or, if material, prorated among cost of goods sold and inventories. Purchases of direct materials are recorded as debits to the Materials Inventory account at their standard cost. If the company recognizes price variances at the time of purchase, any difference in price from the standard is recorded in a Direct Materials Purchase Price Variance account (a debit if the price is higher than the standard price and a credit if the price is lower than the standard price). The company will probably have a separate variance account for each material used. The credit is to Accounts Payable. When direct materials are requisitioned from materials inventory for use in the production process, the debit to Work-In-Process Inventory is for the standard quantity of materials that should have been used for manufacturing the units manufactured, at their standard cost. The credit to the Materials Inventory account is for the total amount of materials actually used, at their standard cost. The difference is the direct materials quantity variance, and it is recorded in the Direct Materials Quantity (or Usage) Variance account (a debit for an unfavorable variance and a credit for a favorable variance). This isolates the variances so they can be analyzed. It also maintains standard costs in the Work-In-Process Inventory accounts during the production process. At the end of the period, the variances are closed out, either to Cost of Goods Sold or, if they are material, they are usually prorated among Work-In-Process Inventory, Finished Goods Inventory, and Cost of Goods Sold. Question 46: Under a standard cost system, the materials efficiency variances are the responsibility of: a) Production and industrial engineering. b) Purchasing and industrial engineering. c) Purchasing and sales. d) Sales and industrial engineering. (CMA Adapted) Question 47: A favorable materials price variance coupled with an unfavorable materials usage variance would most likely result from: a) Machine efficiency problems. b) Product mix production changes. c) The purchase and use of higher than standard quality materials. d) The purchase of lower than standard quality materials. (CMA Adapted) 1 1 0 Section B Manufacturing Input Variances Question 48: Garland Company uses a standard cost system. The standard for each finished unit of product allows for 3 pounds of plastic at $0.72 per pound. During December, Garland bought 4,500 pounds of plastic at $0.75 per pound, and used 4,100 pounds in the production of 1,300 finished units of product. What is the materials price variance for the month of December? a) $117 unfavorable. b) $123 unfavorable. c) $135 unfavorable. d) $150 unfavorable. (CMA Adapted) The following Information Is for the next three Questions: ChemKing uses a standard costing system in the manufacture of its single product. The 35,000 units of raw material in inventory were purchased for $105,000, and 2 units of raw materials are required to produce 1 unit of final product. In November, the company produced 12,000 units of product, which was as budgeted. The standard allowed for material was $60,000, and there was an unfavorable quantity variance of $2,500. Question 49: ChemKings standard price for one unit of material is: a) $2.00 b) $2.50 c) $3.00 d) $5.00 Question 50: The units of material used to produce November output totaled: a) 12,000 units. b) 12,500 units. c) 23,000 units. d) 25,000 units. Question 51: The materials price variance for the units used in November was: a) $2,500 unfavorable. b) $11,000 unfavorable. c) $12,500 unfavorable. d) $3,500 unfavorable. (CMA Adapted) 1 1 1 Manufacturing Input Variances CMA Part 1 Direct Labor Variances As with the materials variance, the total labor variance (also called the flexible budget variance) is the difference between the standard labor costs for the actual level of output (the flexible budget) and the actual costs incurred by the company. Also similar to the materials variance, this total variance is attributable to variances in both labor rates and labor usage. This means that the company either paid a different wage rate than standard or used a different number of labor hours than standard for this level of output, or both. Because this is so similar to variance analysis for materials, we will not cover it in detail again, but the total labor variance can be broken down into the labor rate variance (a price variance) and the labor efficiency variance (a quantity variance). These are calculated in the exact same manner as the direct material cost and usage variances, but simply have different names. The Labor Rate Variance The labor rate variance is calculated as the direct materials price variance was calculated : (Actual Rate - Standard Rate) x Actual Hours or (AP - SP) x AQ The Labor Efficiency Variance The labor efficiency variance is calculated the same way as the direct materials quantity variance was calculated: (Actual Hours - Standard Hours for Actual Output) x Standard Rate or (AQ - SQ) x SP Note: On the Exam, you need to be able to use these formulas not only to solve for the variance itself, but also to solve for any of the Individual variables in these equations. In this second case, you will be given the variance and asked to solve for one of the quantity or price numbers, either actual or standard. This is simply using the same formulas, but solving for a different variable. Accounting for Direct Labor Variances in a Standard Cost System The production payroll is recorded by debiting Work-In-Process Inventory for the total number of standard hours for the units manufactured at the standard hourly rate. The credit is to accrued payroll at the total number of hours actually spent and at the actual hourly rate. The difference is recorded in the Direct Labor Rate Variance (the price variance) and the Direct Labor Efficiency Variance (the quantity variance) accounts. Unfavorable variances are debits, and favorable variances are credits. As with direct materials variances, the variances are closed out at the end of the period, either to Cost of Goods Sold or, if they are material, prorated among Work-In-Process Inventory, Finished Goods Inventory, a nd Cost of Goods Sold. Note: The company must also choose how the costs of employee related costs such as employee benefits and payroll taxes will be treated. They may be included in the cost of direct labor or treated as an overhead and allocated to the units produced. In some cases, these costs may be treated as a period cost. The method in which these costs are treated may have a small effect on cost of goods sold, income or inventory. Only in cases where direct labor is a large portion of the total expenses will this difference be significant.
Posted on: Mon, 11 Nov 2013 15:14:48 +0000
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