AFD W5 Lecture Power Point

8/8/2019 AFD W5 Lecture Power Point

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Accounting for Decision Making

Week 5 Lecture

(Seminar 6

Controlling the Plan )


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Main Topics: Feedback and feed forward control

systems

Fixed budget vs flexible budget Standard cost Variance analysis (i.e. sales price

variance, total overhead variance,material cost and labour costvariances)

Profit reconciliation statement


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Control Systems

FEEDBACK SYSTEMS Where actual performance is measuredagainst budget and corrective action is

taken after the event like a gas centralheating system or air conditioning.


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Control Systems

FEEDBACK SYSTEMS


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Control Systems

FEEDFORWARD SYSTEMS Where predictions are made of expected

outcomes and compared to budget rolling forecast . Action can be takenBEFORE the event occurs


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Performance Reporting System

Measure actual results with reasonable accuracy

Speed of issue and total accuracy

Identify variances (against plan) and the reasons for them

Provide non-financial information (critical success factors)as well as traditional accounting information

Distinguish between controllable and non-controllable

items (Responsibility Accounting)

Be prepared in such a way that there is no bias

Issued to everyone who needs to know.

For a performance reporting system to be effective,it must:


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Fixed BudgetA fixed budget is prepared at thebeginning of the budgeting period and is

valid for only the planned level of activity.


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Fixed BudgetFixed Budget

Units sold 12,000

Revenues @$120 $1,440,000

Variable costs

Direct materials @$60 x 12,000 720,000Direct Labor @$16 x 12,000 192,000

Production overhead * 144,000

Total variable costs 1,056,000

Contribution margin 384,000

Fixed costs 276,000

Profit $108,000

*overhead absorption rate @ $12 x 12,000


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Fixed-Budget Variance

- For planning and control, and for performanceevaluation, we are interested to study thevariances between the actual results and the

budgeted results.- A favorable variance - denoted F has theeffect of increasing profit relative to thebudgeted amount. An unfavorable variance -

denotedU

has the effect of decreasing profitrelative to the budgeted amount.


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ActualResults

Fixed-Budget

VarianceFixed

Budget

(1) (2) = (1) -(3) (3)

Units sold 10,000 2,000 U 12,000

Revenues $1,250,000 $190,000 U $1,440,000

Variable costs

Direct materials 621,600 98,400 F 720,000

Direct Labor 198,000 6,000 U 192,000

Production overhead 130,500 13,500 F 144,000

Total variable costs 950,100 105,900 F 1,056,000

Contribution margin 299,900 84,100 U 384,000Fixed costs 285,000 9,000 U 276,000

Profit $14,900 $93,100 U $108,000

$93,100 U

Fixed-budget variance


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A fixed budget is suitable for planning purposes,but it is inadequate for evaluating how costs arecontrolled.

If the actual activity during a period differs fromwhat was planned, it would be misleading tosimply compare actual costs to the fixed budget,as the actual costs are based on one level of

activity while the fixed budget costs are basedon a different level of activity.

If activity is higher than expected, variable costsshould be higher than expected; Otherwise, the

variable costs should be lower than expected.

What is wrong with a fixed budget?


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I dont think I can

answer the questionusing a fixed budget.

How much ofthe favorable cost

variance is due to loweractivity, and how much isdue to better cost control?

What is wrong with a fixed budget?


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A flexible budgetcalculates budgets revenuesand budgeted costs based on the actual

output level in the budget period.

The flexible budget is prepared at the end of aperiod after the actual output level is known.

Flexible Budget


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1.The budgeted selling price per unit is the sameone used in preparing the fixed budget.

2.The budgeted variable costs are the same perunit costs used in the fixed budget.

3.The budgeted fixed costs are the same fixedbudget amount (assuming the company is stillproducing within the relevant range).

Flexible Budget

In preparing the flexible budget:

The only difference between the fixed budget and theflexible budget is that the fixed budget is prepared forthe planned output, whereas the flexible budget is

based on the actual output.


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Flexible Budget FlexibleBudget

Units sold 10,000

Revenues @120 x 10,000 $1,200,000

Variable costs

Direct materials @60 x 10,000 600,000

Direct labor @$16 x 10,000 160,000

Production overhead @12 x 10,000 120,000

Total variable costs 880,000

Contribution margin 320,000

Fixed costs ( within the relevant range) 276,000

Profit $44,000


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Fixed versus Flexible BudgetsFixed Budgets

Used for planningpurposes.

Prepared at thebeginning of theperiod.

Based upon

projected level ofactivity.

Flexible Budgets

Used for controlpurposes.

Prepared at theend of the period.

Flexed toaccommodate

actual level ofactivity.


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ActualResults

FlexibleBudget

Variance

FlexibleBudget

SalesVolume

VarianceFixed

Budget

(1) (2)= (1) -(3) (3) (4)= (3) -(5) (5)

Units sold 10,000 0 10,000 2,000 U 12,000

Revenues $1,250,000 $50,000 F $1,200,000 $240,000 U $1,440,000

Variable costs

Direct materials 621,600 21,600 U 600,000 120,000 F 720,000

Direct Labor 198,000 38,000 U 160,000 32,000 F 192,000

Productionoverhead 130,500 10,500 U 120,000 24,000 F 144,000

Total variablecosts 950,100 70,100 U 880,000 176,000 F 1,056,000

Contributionmargin 299,900 20,100 U 320,000 64,000 U 384,000

Fixed costs 285,000 9,000 U 276,000 0 276,000

Profit $14,900 $29,100 U $44,000 $64,000 U $108,000

$93,100U

Fixed-budget variance

$29,100 UFlexible-budget variance


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ActualResults

Flexible-

BudgetVariance

FlexibleBudget

(1) (2) = (1) -(3) (3)

Units sold 10,000 0 10,000

Revenues $1,250,000 $50,000 F $1,200,000

Variable costs

Direct materials 621,600 21,600 U 600,000

Direct labor 198,000 38,000 U 160,000

Production overhead 130,500 10,500 U 120,000

Total variable costs 950,100 70,100U

880,000Contribution margin 299,900 20,100 U 320,000

Fixed costs 285,000 9,000 U 276,000

Profit $14,900 $29,100 U $44,000

Flexible-Budget Variance


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ActualResults

Flexible-

BudgetVariance

FlexibleBudget

(1) (2) = (1) -(3) (3)

Units sold 10,000 0 10,000

Revenues $1,250,000 $50,000 F $1,200,000

Variable costs


Direct labor 198,000 38,000 U 160,000


Total variable costs 950,100 70,100 U 880,000

Contribution margin 299,900 21,100 U 320,000

Fixed costs 285,000 9,000 U 276,000

Profit $14,900 $29,100 U $44,000


SALES PRICE VARIANCE:

The difference in sales value for the periodcaused by the actual selling price being different fromthe budgeted selling price


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ActualResults

Flexible-

BudgetVariance

FlexibleBudget

(1) (2) = (1) -(3) (3)

Units sold 10,000 0 10,000

Revenues $1,250,000 $50,000 F $1,200,000

Variable costs


Direct labor 198,000 38,000 U 160,000




Fixed costs 285,000 9,000 U 276,000

Profit $14,900 $29,100 U $44,000


TOTALOVERHEAD VARIANCE:

This compares the overhead absorbed with the actualoverhead expenditure. The resultant variance is theunder/over absorption of overheads for the period.


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The unfavourable total overhead variance could dueto one or more of the following:

Under estimation of the absorption rate (either by under

estimation of total production overhead or overestimation of the absorption base) Less actual total units of the absorption base were used

than the estimated.


Absorptionrate

xActual total units of the

absorption baseincurred during the

period

=Total production

overheadsabsorbed


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ActualResults

Flexible-

BudgetVariance

FlexibleBudget

(1) (2) = (1) -(3) (3)

Units sold 10,000 0 10,000

Revenues $1,250,000 $50,000 F $1,200,000

Variable costs


Direct labor 198,000 38,000 U 160,000




Fixed costs 285,000 9,000 U 276,000

Profit $14,900 $29,100 U $44,000


In the following lecture, we shall focus on theflexible-budget variances for direct materials,direct labor


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ActualResults

Flexible-Budget

VarianceFlexibleBudget

(1) (2) = (1) -(3) (3)

Variable costs


Direct labor 198,000 38,000 U 160,000



What is wrong with the flexible-budget variance fordirect materials and direct labor?


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We have no way to tell if the unfavorable variance isdue to:

1. Inputs are purchased at prices that are too high,or

2. More input is used than is really necessary.

What is wrong with the flexible-budget variance fordirect materials and direct labor?


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I dont think I can

answer the question!

What is wrong with the flexible-budget variance for direct

materials and direct labor?

How much ofthe unfavorable variance isdue to higher input price,and how much is due to

more input us used?


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Standard Cost

Quantity Standards specify how much of an inputshould be used to make a product or provide aservice.

Price Standards specify how much should be paidfor each unit of input.


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Standard Cost

(i) (ii) (i) x (ii)

Inputs

Standard

QuantityPerOutput Unit

Standard

PricePer Input Unit

Standard

Costper Unit

Direct materials(square yard)

2.0 squareyards

$30 persquare yard $60

Direct labour

(laborhour) 0.8 labor hr

$20 per

labourhr $16Production overhead

(machine hour) 0.4 machine hr$30 per

machine hr $12

Total standard unit cost $88

Standard cost card for one unit of product:


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Setting Standard Cost The future period of time covered by the standard should

be determined Relate to prescribed working conditions and practices

and defined levels of activity and operating efficiency

The standard quantities of both direct material and labourshould be determined by scientific methods The standard prices for materials and rates of pay for

labour should be based on those anticipated in thestandard cost period

The psychological effect of setting standards should notbe too tough - they should be attainable, but with hardwork!


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Setting Direct Labour Standards

Quantity(Efficiency)Standards

( 0.8 labor hr)

Should includeallowances for breaks,

personal needs ofemployees, cleanup,

and machinedowntime.

Price(Rate)

Standards($20 / labor hr)

Should include notonly wages earned

but also fringebenefits and other

labour costs


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Standard Quantity Allowed for Actual Output

(i) (ii) (i) x (ii)

InputsStandardQuantity

ActualOutput

StandardQuantity allowed

foractual output

Direct materials 2.0 sq. yards 10,000 20,000 sq. yards

Direct labor 0.8 laborhr 10,000 8,000 labor hrs

What is the standard quantity allowed for eachvariable input for producing the actual output of10,000 units?


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Flexible-Budget Costs

(i) (ii) (i) x (ii)

Inputs

StandardQuantity allowed

foractual output

StandardPrice

Flexible-Budget

Cost

Direct materials 20,000 sq. yards $30 / sq. yards $600,000

Direct labor 8,000 laborhrs $20 / labor hr. $160,000

The flexible-budget costs for each variable input canalso be computed by multiplying the standard price bythe standard quantity allowed for actual output.


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Actual Costs

(i) (ii) (i) x (ii)

InputsActual

QuantityActualPrice

ActualCost

Direct materials 22,200 sq. yards $28 / sq. yards $621,600

Direct labor 9,000 laborhrs $22 / labor hr. $198,000

At the end of the month, the company obtained thefollowing actual costs information for their variableinputs:


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A General Model for Variance Analysis

Cost Variance

Price Variance(Rate Variance)

The difference betweenthe actual price and the

standard price

Quantity Variance(Usage Variance)

(Efficiency Variance)

The difference betweenthe actual quantity andthe standard quantity

allowed for actual output


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The component parts of the direct material and direct labourvariances:


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A General Model for Variance Analysis

Price Variance Quantity Variance

Actual Quantity Actual Quantity Standard QuantityAllowed forActual Output

Actual Price Standard Price Standard Price

AQ(AP - SP) SP(AQ - SQ)

- -

+



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22,200 sq. ydsx

$28/sq. yd.

$621,600

22,200 sq. ydsx

$30/sq. yd.

$666,000

20,000 sq. ydsx

$30/sq. yd.

$600,000

$44,400 FPrice variance

$66,000 Uusage variance

$21,600 U

Materialcost varian

ce

Material Cost Variances


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Direct Materials Quantity VarianceThe unfavourable materials usage variance representsthe company actually used more quantity of directmaterials than what should have been used according tothe standard that has been set. This could due to one ormore of the following:

Personnel manager hired unskilled workers. Works were scheduled inefficiently. Poorly maintained machines.

Inferior quality of materials. Poor supervision Standard quantity was set too tight without careful analysis.


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9,000 Labourhrs.x

$22/hr

$198,000

9,000 Labourhrsx

$20/hr

$180,000

8,000 Labourhrsx

$20/hr

$160,000

$18,000 URate variance

$20,000 UEfficiency variance

$38,000 UL

abourcost varian

ce

LabourCost Variance


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Labor Rate VarianceThe unfavorable direct labour rate variance representsthe company actually paid a higher average hourly labourrate than what should have been paid according to thestandard that has been set. This could due to one or

more of the following:

Poor negotiation skill with labour union. Employed more skilled workers. More overtime work at premium rates.

Tight labour market Standard rate was set too low without careful analysis.


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Labor Efficiency VarianceThe unfavorable direct labor efficiency variancerepresents the company actually used more direct labourtime than what should have been used according to thestandard that has been set. This could due to one or

more of the following:

Poorly trained or motivated workers. Poor quality materials, requiring more labour time in

processing.

Faulty equipment, causing breakdowns and workinterruptions.

Poor supervision of workers. Standard quantity was set too low without careful

analysis.


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Profit Reconciliation Statement

BUDGETEDCONTRIBUTION MARGIN $320,000

VARIANCES:

Sales price variance 50,000

Material price variance 44,400

Material usage variance (66,000) Labour rate variance (18,000)

Labour efficiency variance (20,000)

Total overhead variance (10,500)

TOTAL VARIANCES $20,100

ACTUALCONTRIBUTION MARGIN $299,900


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Glacier Peak Outfitters has the followingdirect material standard for the fiberfill in its

mountain jacket.0.1 kg. of fiberfill per jacket at $5.00 per kg.

Last month 210 kgs of fiberfill were

purchased and used to make 2,000 jackets.The material cost a total of $1,029.

Quick Check 1


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What is Glacier Peak Outfitters actual priceof fiberfill per kg?

What is the standard quantity of fiberfill thatshould have been used to produce 2,000jackets?

What is the materials price variance andusage variance?

Quick Check 1


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Hanson Inc. has the following direct laborstandard to manufacture one Zippy:

1.5 standard hours per Zippy at $6.00 perdirect laborhour

Last week 1,550 direct labor hours wereworked at a total labor cost of $9,610 tomake 1,000 Zippies.

Quick Check 2 Zippy


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What is Hansons actual rate for labour forthe week?

What is the standard hours of labour thatshould have been worked to produce 1,000Zippies?

What is the labour rate variance andefficiency variance?

Quick Check 2 Zippy


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SEMINAR 6

EXAMPLE


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Materials

12.50 kg of tubing @ 3.80 per kg 47.50

1 set of components 152.00 199.50

Labour

Frame Dept.2.00 hrs @ 6 per hr 12.00

Assembly Dept.1.25 hrs @ 10 per hr 12.50 24.50

Total Overheads8.

00

Total cost 232.00

Profit margin 58.00

Sales price 290.00

The standard cost card for producing one Crusader Mountain Bikeshows the following information:


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During the month of May, 4,000 cycles were sold and the actual resultswere as follows:

Sales (4,000 cycles) 1,192,000

Costs

54,000kg of tubing 175,500

4,000 component sets 620,000

7,600 Framing department hours 49,400

4,800 Assembly department hours 49,200

Overheads 30,500 924,600

Profit 267,400


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Material Cost Variance:

Tubing

Components

Act QtyX

Act price

175,500

620,000

Act QtyX

Std price

54,000

X3.8

205,200

4,000X

152

608,000

PRICEVARIANCE

29,700 F

12,000 U

Std QtyX

Std price

4,000 x 12.5

X3.8

190,000

4000 x 1X

152

608,000

USAGEVARIANCE

15,200 U

nil


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Labour Cost Variance:

Frame

Assembly

Act QtyX

Act price

49,400

49,200

Act QtyX

Std price

7,600

X6

45,600

4,800X

10

48,000

RateVARIANCE

3,800 U

1,200 U

Std QtyX

Std price

4,000 x 2

X6

48,000

4000 x 1.25X

10

50,000

EfficiencyVARIANCE

2,400 F

2,000 F


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7) Total overhead variance

Overheads absorbed (recovered) 32,000(4,000 x 8)

Actual overheads 30,500Overhead variance 1,500OVER ABSORPTION (FAVOURABLE)


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9) Whose Responsibility? Likely Causes?SALES PRICE (F)

MATERIAL PRICETubing (F),Components (U)

MATERIAL USAGE

Tubing (U)

LABOUR RATEFraming (U)

Assembly (U)

LABOUR EFFICIENCY

Framing (F)Assembly (F)

OVERHEADS (F)

Sales manager: Price inflation, Good market, Look at costs was

increase due to higher costs?

Buyer: Better /poor negotiation skill of the purchasing manager.

Adopted a lower-price / higher-price supplier. Purchased lower-

quality / higher quality materials etc.

Production managers: Personnel manager hired unskilled workers.

Works were scheduled inefficiently. Poorly maintained machines

etc.

HR manager : Poor negotiation skill with labour union. Employed more

skilled workers. More overtime work at premium rates etc.

Production managers: Better trained or motivated workers. Better

quality materials, requiring less labour time in processing. Less

faulty equipment, causing less breakdowns and work interruptions

etc.

All managers: The actual costs of the production overheads costing

less than the estimated. Less actual quantities of the variable

overhead items were used than the estimated. Over estimation of

the absorption rate etc.


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Seminar Question

As the Chief Executive of a manufacturing company,you are asked to make decisions on the followingmatters:

1. Your company uses a key material to make itsproduct. Each unit that you make uses 6 kilogramsof the material and you are currently paying 50p perkilo. You have the opportunity to purchase acheaper quality of this material and save 10% of the

price. However, wastage will increase so it will nowneed 6.5 kilograms to make each unit. What shouldyou do? What effect would the decision have onprofits if you made and sold 120,000 units everymonth?


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Seminar Question

2. The product you make uses 2 hours of labour foreach unit and that costs 6 per hour. You couldrecruit better trained labour at 8 per hour and it

would only take 1 hours to make each unit. Whatshould you do? What effect would the decisionhave on profits if you made and sold 120,000 unitsevery month?


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Seminar 6:Questions 1 2

Students are required to hand in

solutions to the assigned exercises at

the beginning of the tutorial sessions.

Tutorial Exercise


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End of

Week 5

Lecture


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210 kgs. 210 kgs. 200 kgs.

$4.90 per kg. $5.00 per kg. $5.00 per kg.

= $1,029 = $1,050 = $1,000

Price variance$21 favorable

Usage variance$50 unfavorable

Actual Quantity Actual Quantity Standard Quantity


Quick Check 1


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Actual Hours Actual Hours Standard Hours

Actual Rate Standard Rate Standard Rate

Quick Check 2

Rate variance$310 unfavorable

Efficiency variance$300 unfavorable

1,550 hours 1,550 hours 1,500 hours

$6.20 per hour $6.00 per hour $6.00 per hour

= $9,610 = $9,300 = $9,000

Zippy

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