Solution manual cost accounting by LauderbachCONTROL AND EVALUATION OF COST CENTERS

The material price variance will be favorable, while the material use, labor efficiency, and VOH efficiency variances will probably be unfavorable.. The labor rate variance will be favor

CHAPTER 11

CONTROL AND EVALUATION OF COST CENTERS

11-1 Outsourcing and Standard Costs

The short life cycle of toys suggests that manufacturers would not benefit from using standard costs However, they must bid for

business, which indicates that they examine the toy closely before setting a price This analysis is tantamount to developing a standard cost

11-2 Responsibility for Variances

1 The material price variance will be favorable, while the material use, labor efficiency, and VOH efficiency variances will probably be unfavorable Quality could also suffer

2 Before the company changes its standards, we should expect all efficiency variances to be favorable because of the reduced diversity The company might even find material price savings from buying fewer types of materials and components

3 The same things we mentioned in part 2 should happen here Here the company is reducing complexity of products Simplification should result in products that are easier to manufacture

4 The labor rate variance will be favorable, the labor and variable overhead efficiency variances probably unfavorable

11-3 Learning Curves

Auto assembly plants do experience learning effects during

changeovers Assembly lines run slower for a while, then move up to full speed as the workers become more familiar with the operations on the new models Aircraft plants experience learning effects The learning effect was discovered in an aircraft plant in the 1930s The others will not show learning effects because they are machine-driven, processing operations

11-4 Long-Term Contracts

The principal reasons for using long-term contracts are to ensuresupplies and to obtain firm prices Many companies willingly sacrificethe possibility of paying too much (if prices subsequently fall) to manage the risk of paying too much (if prices rise) or not having an ensured supply For Stanley the ensured supply is not a reason becausesupplies are available at competitive prices The price risk is

therefore Stanley’s principal motivation

The principal disadvantage is the possibility of losing lower prices in the future Depending on the terms of the agreement and the commodity or product, companies might also risk having too great a supply If demand for the end product falls and the agreement requires taking a minimum quantity, the company could have unwanted inventory The company might also lose flexibility to substitute other commodities

or products if it is required to take a minimum quantity Consider the following statement from Palm’s 2001 Form 10-K

“Due to supply constrained inventories experienced during the first three quarters of fiscal year 2001, we built inventory levels for certain components with long lead times and entered into certain longer-term commitments for certain components In the fourth quarter, the sudden and unanticipated significant decrease in demand for our productscaused our inventory levels to exceed our forecasted requirements We donot currently anticipate that the excess inventory subject to this provision will be used at a future date based on our current 12-month forecast.”

11-5 Productivity Gains

Efficiency variances were favorable (or at least some efficiency

variances were favorable) and at least some price or rate variances wereunfavorable Increases in productivity typically mean increases in efficiency The statement that increased productivity "partially offsetincrease in our input costs" indicates that the company paid more for inputs, which gives rise to rate or price variances

11-6 Responsibility for Variances

Memorandum

To: Henry Berger

From: Student

Date: Today

Subj: Identification of rejects

Jack Smith has questioned our allocation of rejects that we cannot identify by department on the basis of identifiable rejects

The validity of Smith's claim can neither be verified nor refuted, given the available information Obviously, the claim of

discrimination would be valid if the proportions, by department, of unidentifiable rejects do not equal the proportion of identifiable rejects But, by definition, it is impossible to determine the

responsibility for unidentifiable rejects Hence, Smith's claim can beneither proved nor disproved And, from this analysis, it is clear that we are actually charging managers with an arbitrary allocation: they are being charged with costs over which they cannot be shown to have control This violates the principle of controllability in

responsibility reporting

One possibility is to stop the allocation entirely, charging the managers with only the rejects specifically identifiable as having beencaused by their departments If we were to adopt JIT principles, we would perform continual inspection, which would eliminate the problem Another possibility is to develop new evaluation procedures that can better identify the sources of rejects This might require inspecting after each operation rather than after the total assembly operation is complete Even with revised inspection procedures, it might not be possible to assign all rejects Moreover, the cost of the new

inspection approach requires justification on the basis that the

benefits to be received will be greater than the cost of the procedure.11-7 Significance of Variances

Even if total actual costs do not exceed total budgeted costs: (1)there can be offsetting total variances for individual elements of cost(materials, labor, individual overhead costs); and (2) a particular cost element can be as budgeted in total, but still have offsetting prices and quantity variances.

In both cases, investigation may be needed A cheaper material might have been introduced into the production process, creating a favorable material price variance, but also leading to increased labor time requirements, or an increase in scrapped materials These would create, respectively, an unfavorable labor efficiency variance and an unfavorable material use variance The use of lower-paid temporary workers might result in offsetting labor rate and labor efficiency variances Any of these situations is acceptable if the result of properly approved decisions

One danger in relying on a comparison of totals is that surprises may be in store in future periods For example, a decline in labor efficiency may have occurred and require action The decline could be masked in one month because of a nonrecurring favorable variance in another cost factor Even if future costs related to some elements can

be expected to be lower because of more favorable circumstances, the failure to correct the unfavorable situation with labor efficiency willresult in profits being lower than they could have been

Failure to investigate variances wastes the potential of a major tool for spotting areas for possible saving areas where control might not be effective Variance analysis does not tell you why costs are lower or higher than budgeted, only that rates and quantities of

resources differed from standards

11-8 Basic Material and Labor Variances (10 minutes)

This exercise stresses that actual output is the basis for

calculating variances The standard quantities, from the budget

column, are 0.4 yards of material (36,000/90,000) and 0.2 hours of labor (18,000/90,000)

Material use variance (45,000 - [110,000 x 0.4]) x $5 $5,000 ULabor efficiency variance (21,500 - [110,000 x 0.2]) x $15 $7,500 F11-9 Basic Variance Analysis (15 minutes)

This exercise is straightforward, but some students will have trouble with materials because the quantity used exceeds the quantity purchased Despite their continual exposure to inventories, students sometimes miss the point that purchases can well be less than use Some students also might have difficulty determining standard labor hours They do not have to make the calculation ($24/$12 = 2 standard hours) to complete the assignment We also give the materials

variances in a different format You might wish to show students that format is not the critical element

Materials variances

Price variance:

Actual cost of purchases, $5.90 x 3,200 $18,880

Budgeted cost, 3,200 pounds at $6 19,200

Favorable variance $ 320 F

Use variance:

Standard cost of materials used, 6,200 x $6 $37,200

Standard cost of standard quantity, 1,200 x 5 x $6 36,000

Unfavorable use variance $ 1,200 ULabor variances

Actual Cost Budget for 2,250 hours Budget for 1,200 Units $12 x 2,250 1,200 x 2 x $12 or 1,200 x $24

$27,225 $27,000 $28,800

$225 U $1,800 F

Rate variance Efficiency variance

Variable overhead variances

Actual Cost Budget for 2,250 Hours Budget for 1,200 Units $6 x 2,250 1,200 x 2 x $6 or 1,200 x $12 $13,800 $13,500 $14,400

$300 U $900 F

Budget variance Efficiency variance

This exercise lends itself to using the differences between standard and actual rates to determine price/rate variances

Material price variance = ($6.00 - $5.90) x 3,200 $ 320 F

Labor rate variance = ($12.00 - $12.10) x 2,250 $ 225 U

11-10 Standard Cost Relationships (15-20 minutes)

This basic exercise deals with the concept of standards as "shouldbe" quantities and costs It also treats relationships

3 30,000 units (90,000 hours/3 hours per unit)

4 25,000 units (100,000 pounds/4 pounds per unit)

5 80,000 pounds (60,000 hours/3 hours per unit) = 20,000 units; 4 pounds x 20,000 units = 80,000 pounds

6 $297,000 variable overhead 66,000 lbs/4 lbs per unit = 16,500 units, 16,500 units x 3 hours per unit = 49,500 hours x $6 per hour =

$297,000 variable overhead

$792,000 labor, 49,500 hours x $16 per hour = $792,000 labor

11-11 Basic Learning Curve (10-15 minutes)

1 and 2 The schedule below shows results through 8 units

Standard pounds 8 $40 standard cost/$5 standard price

Units produced 5,000 40,000 standard use/8 standard pounds per unit

Pounds used 39,680 40,000 - ($1,600 favorable use variance/$5 standard price per pound)

Amount paid $227,000 $2,000 U price variance + (45,000 x $5)

11-13 Ethics and Overhead Assignment (10 minutes)

Grayson has a legitimate complaint The controller is certainly not doing the job she should, from a strictly managerial perspective The company is not getting the best information about product costs andmanagers could be making poor decisions From an ethical viewpoint thesituation is less clear However, it is certainly possible to argue that the controller is violating the Standards She is probably

violating the objectivity standard by not presenting all of the " relevant information that could reasonably be expected to influence an intended user's understanding " She is probably violating the competence standard to " prepare complete and clear reports and recommendations after appropriate analyses of relevant and reliable information."

11-14 Fundamentals of Standard Costs and Variances (10-15 minutes)

1 $74

Clay (20 pounds x $3) $60

Direct labor (1/2 hour x $16) 8

Variable overhead (1/2 hour at $12) 6

Total standard variable cost $74

Budget variance Use variance

11-15 Spoilage Variance (15-20 minutes)

This is a challenging exercise, though the appendix provides the format for solving it

$1,200 U $3,600 U

Use variance Spoilage varianceDirect labor:

Standard Quantity Standard Quantity

Actual Quantity at for 2,000 units at for 1,800 Good Units

Actual Cost Standard Price Standard Price at Standard Price 3,900 x $10 2,000 x $20 1,800 x $20

$16,500 $15,600 $16,000 $14,400

$900 U $400 F $1,600 U

Budget variance Efficiency variance Spoilage variance

11-16 Evaluation in JIT Manufacturing (10 minutes)

The company has improved in all ways but one

Both processing time and cycle time have dropped since July The drop in cycle time could be especially important for meeting customer demands The inventory data suggest that the company could cut cycle time even more because there is still a 19 day cycle of materials to in-process goods to finished goods (6 + 9 + 4 days).

Production rose from July to September, which is good if demand washigher in September We do not know whether the rise is good or bad, from production's point of view

Defective units fell, as did the percentage of defectives, from 1.2% (90/7,440) to 8% (62/7,720) The company would like defectives

to drop to zero and is still short of that goal

The decline in days supply of materials is good The drop from 9 days to 6 days supply (50%) is considerable The decline in in-processinventory is also good, but the increase in finished goods supply is not However, the increase in finished goods supply might be the result of market forces or temporary conditions having to do with shipping goods to customers

11-17 Revising Standard Costs, Target Costs (15 minutes)

1 Revised Standard Variable Cost

Even with this simple assignment, you might wish to point out that increases in efficiency can offset increases in rates, and in someindustries, must so offset rate increases for companies to remain competitive

11-18 Learning Curve (15 minutes)

It is also possible to use the totals

Materials and components ($25,000 x 8) $200,000

Direct labor and variable overhead (from 16-11) 327,680

Total variable cost $527,680

Desired contribution margin ($15,000 x 8) 120,000

Required price $647,680

Dividing $647,680 by 8 gives $80,960

2 $72,768 All we need to do is extend the analysis in assignment 16-11 by one row, from 8 to 16 batches At 8 batches we had an averagecost of $40,960, so after 16 batches we have $32,768 ($40,960 x 80) Materials and components $25,000

Direct labor and variable overhead 32,768

Total variable cost $57,768

Desired contribution margin 15,000

Required price $72,768

3 $89,130 We must first redo the learning curve using the 85% rate

We show the total costs, even though they are not needed for the

Materials and components $25,000

Direct labor and variable overhead, above 49,130

Total variable cost $74,130

Desired contribution margin 15,000

items related to the sensitivity of costs to changes in volume One isthat changes in the learning rate (80% to 85% here) make a sizable difference in average costs, total costs, and therefore target prices There was an $8,170 decline in average costs ($74,130 - $65,960) and therefore in prices, as learning declined The other is that

increasing volume has a significant effect, as the difference in costs and prices as we went from four batches to eight batches shows

This might also be a good time to emphasize that the lower the learning rate, the better the results Students should see this when reminded that the learning rate is the percentage to which the average declines as output doubles The lower the rate, the lower each

$23,110 actual labor cost, 1,900 actual hours x $12 standard rate +

$310 unfavorable rate variance

$1,200 favorable efficiency variance, 2,000 standard hours - 1,900actual hours = 100 hours under standard; 100 x $12 = $1,200

(b) $400 favorable rate variance, 8,400 actual hours x $10 = $84,000 budgeted cost less $83,600 actual cost = $400

8,200 standard hours, 8,400 actual hours - ($2,000 unfavorable efficiency variance/$10) standard rate per hour Or, $2,000/$10 = 200 hours over standard, so that 8,400 actual hours are 200 over standard 16,400 units produced, 8,200 standard hours/0.50 standard hours perunit

(c) 6,000 standard hours, 3,000 units x 2 hours per unit

5,850 actual hours, efficiency variance of $1,800F/$12 standard rate = 150 hours below standard; 6,000 standard - 150 = 5,850

$71,100 actual labor cost (5,850 actual hours x $12 = $70,200 budget for 5,850 hours, plus $900 unfavorable rate variance = $71,100)(d) 2,000 units produced, 6,000 standard hours/3 hours per unit

$4 standard rate, $24,500 actual cost + $300 favorable rate

variance - $800 unfavorable efficiency variance = $24,000 standard costfor 6,000

standard hours $24,000/6,000 = $4

6,200 actual hours, 6,000 standard hours + ($800 unfavorable

efficiency variance/$4 standard rate) Or, 200 hours over standard, from $800/$4

11-21 Variance Analysis (15-20 minutes)

$1,750 U $22,667 F

Rate variance Efficiency variance

Overhead:

Budgeted Cost for

Actual Cost Production of 200,000 $840,000 + ($11 x 200,000/6) $1,288,500 $1,206,667

$81,833 U

Total variance

Note to the Instructor: You might wish to point out that the company can find the variable overhead efficiency variance and the combined fixed and variable overhead budget variances The efficiency variance is $12,467 F, which is the 1,133 favorable direct labor hours (33,333 standard minus 32,200 actual) times the $11 variable overhead rate Then there is a $80,700 unfavorable total budget variance Thisassignment relies on the discussion of separating actual overhead into its fixed and variable components

11-22 Performance Reporting (15 minutes)

1 Because the report uses static budget allowances based on budgeted output, not actual output, we cannot tell from it whether performance was above or below standard A revised, more informative report

* All listed costs are variable, so we can compute per-unit budgeted costs by dividing the original budgeted amounts by budgeted production

of 4,000 units Alternatively, we could simply multiply the budgeted costs at 4,000 units by 120%, to give budgeted amounts for 4,800 units

2 The memorandum to Woods should cover the following points.

One purpose of variance analysis is to identify the sources of differences between actual costs and standard costs Standard costs should be related to flexible budgets that change with the quantity of output We have been comparing actual costs with static budgets Static budgets are set at the beginning of the period and are not revised if output differs from the original budget

To evaluate production managers requires that we analyze the

differences that they can control Accordingly, we should show

efficiency variances on the reports Whether we should show rate or budget variances depends on whether the production managers can controlthose variances

Although we should adjust our budgets based on actual output, we should be concerned if actual output differs from budget

Manufacturing managers under our current system are motivated to

underproduce (in relation to budget) to keep their costs low In the proposed system, managers might overproduce to keep workers busy and eliminate efficiency variances

11-23 Variances Relationships Among Costs (30 minutes)

1 (a) $2.00 per pound, $8.00 per unit of product

Actual material cost (from 3)

Standard number of hours required to produce 8,000 units

8,000 units x 0.50 hours per unit (computed in 1b) 4,000

Actual hours worked (computed in 5) 4,100

Hours over standard 100

Standard variable overhead at standard rates

8,000 units x $4 per unit (computed in 1c)

favorable budget variance.

11-24 Standards Machine-Hour Basis (25 minutes)

1 $6.00

Materials (1 pound x $4 per pound) $ 4.00

Variable overhead ($10 x 1/5 hours) 2.00

Budget for Standard Cost

Actual Quantity Used for 31,000 units 31,500 x $4 31,000 x $4 $126,000 $124,000

$2,000 U

Use variance

Variable overhead variances

Budget for Standard Cost for Actual Cost Actual Quantity Used 31,000 units 6,140 x $10 31,000 x $2 $62,200 $61,400 $62,000

$800 U $600 F

Budget variance Efficiency variance

11-25 Standards in a Service Function (20 minutes)

Labor rate variance = $26,500 - (1,790 x $14)

Equals standard labor cost $22,008

Minus actual hours x standard rate, above 25,060

Unfavorable labor efficiency variance $ 3,052

2 At least some of the labor efficiency variance is probably

attributable to idle time, rather than inefficiency Each technician worked an average of 120 hours (1,790/15), and a normal work month is about 154 hours (22 days times 7 hours) If the volume of work does not support keeping everyone busy, the labor efficiency variance does not reflect the inability to perform work in the standard time

Note to the Instructor: You might wish to pursue this assignment further Remind the class that using standards (and budgets, to which standards are related) to pressure employees might result in cutting corners Were that to happen here, the consequences could be much worse than they are in most other situations because a poorly done testmight lead to a patient's receiving the wrong treatment

11-26 Target Costing (15 minutes)

We first need to calculate the combined direct labor and variableoverhead rate, $18.45, ($15 x 1.03) + $3

Target cost $24.50

Materials 17.50

Target for direct labor and variable overhead $ 7.00

Divided by combined rate, above $18.45

Target hours 0.3794

Percentage reduction, (.40 - 3794)/.40 0.0515

A 5.2% reduction in direct labor time will meet the objective

Of course, we cannot determine whether the company can meet that

objective That is a task for value engineering

11-27 Determining a Base for Cost Standards (15-20 minutes)

1

Wage Rate Units Standard

per Hour per Hour Cost

$1,057,500 $1,200,000 $142,500 UCurrently attainable (1,410,000 x $0.833)

$1,174,530 $1,200,000 $ 25,470 U

3 The requirement to comment on the results focuses on the

interpretation of "standard" and provides an opportunity to discuss theproblems of setting standards Actual results were closest to the standard set using currently attainable performance, as we would

expect It could be that the new materials-handling equipment is not yet broken in, giving rise to the variance

Both alternatives, historical and ideal performance, gave large variances for obvious (in this case) reasons Historical performance ignores the changed conditions, ideal performance is much above

currently attainable performance

Memorandum

To: Bonnie Gardella

From: Student

Date: Today

Subj: Basis for standard costs

Currently attainable performance gives the best standard for

planning and budgeting Both of the alternatives gave large variances

in labor cost, so they will create problems if we use them for

budgeting However, some JIT manufacturers do use ideal performance as

a goal and we might therefore consider ideal standards if we can

resolve the problem of budgets We might also have motivational

problems using ideal standards unless we adopt JIT principles

wholeheartedly

11-28 Kaizen Costing (15 minutes)

Current One Quarter Two Quarters Three QuartersCutting time 80 78.4 76.8 75.3

Polishing time 30 29.4 28.8 28.2

Total time 110 107.8 105.6 103.5

Total cost $1,980 $1,940 $1,901 $1,863

Each time is 98% of the previous value

Note that the reductions slow because they are percentages of a

declining base Nonetheless, the fall is significant The managers will use these values as targets for the coming periods, instead of thestatic targets that regular standards provide

11-29 Learning Curve in Administrative Work (20 minutes)

About eight to nine days, as calculated below This assignment differs from others because it states time in days, not hours or cost Some students will have trouble deciding how to proceed, but the

calculations are straight-forward The total requirement of 640 forms for each worker is 16 batches of 40 forms each, so the task is to find out how long it takes to process 16 batches Without learning the taskwill take about 16 days

Output Average Time (in days) Total Time (in days)