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Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Chapter 11Chapter 11
Flexible Budgeting andthe Management of
Overhead and SupportActivity Costs
Flexible Budgeting andthe Management of
Overhead and SupportActivity Costs
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Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
L
earningObjective1
L
earningObjective1
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Flexible BudgetsFlexible Budgets
Hmm! Comparingstatic budgets
with actual costsis like comparing
apples and oranges.
Static budgets areprepared for a single,
planned level ofactivity.
Performanceevaluation for
overhead is difficultwhen actual activity
differs from theplanned level of
activity.
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Considerthe followingexample from
the CheeseCompany . . .
Hmm! Comparingstatic budgets
with actual costsis like comparing
apples and oranges.
Flexible BudgetsFlexible Budgets
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Static Actual
Budget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs
Indirect labor 40,000$
Indirect materials 30,000
Power 5,000
Fixed costsDepreciation 12,000
Insurance 2,000
Total overhead costs 89,000$
Static Budgets andStatic Budgets and
Performance ReportsPerformance Reports
U = Unfavorable varianceCheese Company wasunable to achieve the
budgeted level of activity.
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Static Actual
Budget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs
Indirect labor 40,000$ 34,000$ $6,000 F
Indirect materials 30,000 25,500 4,500 F
Power 5,000 3,800 1,200 F
Fixed costsDepreciation 12,000 12,000 0
Insurance 2,000 2,000 0
Total overhead costs 89,000$ 77,300$ $11,700 F
Static Budgets andStatic Budgets and
Performance ReportsPerformance Reports
F = Favorable variance since actual costsare less than budgeted costs.
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Static Actual
Budget Results Variances
Machine hours 10,000 8,000 2,000 U
Variable costs
Indirect labor 40,000$ 34,000$ $6,000 F
Indirect materials 30,000 25,500 4,500 F
Power 5,000 3,800 1,200 F
Fixed costsDepreciation 12,000 12,000 0
Insurance 2,000 2,000 0
Total overhead costs 89,000$ 77,300$ $11,700 F
Since cost variances are favorable, havewe done a good job controlling costs?
Static Budgets andStatic Budgets and
Performance ReportsPerformance Reports
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I dont think I cananswer this question
using a static budget.
I do know thatactual activity is belowbudgeted activity which
is unfavorable.But shouldnt variable costs
be lower if actual activityis below budgeted activity?
Static Budgets andStatic Budgets and
Performance ReportsPerformance Reports
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The relevant question is . . .
How much of the favorable cost variance is dueto lower activity, and how much is due to good
cost control?
To answer the question,we must
the budget to theactual level of activity.
Static Budgets andStatic Budgets and
Performance ReportsPerformance Reports
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Flexible BudgetsFlexible Budgets
Central Concept
I
f you can tell me what your activity wasfor the period, I will tell you what your costsand revenue should have been.
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Advantages of Flexible BudgetsAdvantages of Flexible Budgets
Improve performance evaluation.
May be prepared for any activitylevel in the relevant range.
Show revenues and expensesthat should have occurred at theactual level of activity.
Reveal variances due to good cost
control or lack of cost control.
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Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
L
earningObjective2
L
earningObjective2
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Preparing a Flexible BudgetPreparing a Flexible Budget
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Variable Total Flexible Budgets
Cost Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor 4.00
Indirect material 3.00
Power 0.50
Total variable cost 7.50$
Fixed costsDepreciation 12,000$
Insurance 2,000
Total fixed cost
Total overhead costs
Preparing a Flexible BudgetPreparing a Flexible Budget
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Variable Total Flexible Budgets
Cost Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor 4.00 32,000$
Indirect material 3.00 24,000
Power 0.50 4,000
Total variable cost 7.50$ 60,000$
Fixed costsDepreciation 12,000$
Insurance 2,000
Total fixed cost
Total overhead costs
Preparing a Flexible BudgetPreparing a Flexible Budget
Variable costs are expressed asa constant amount per hour.
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Variable Total Flexible Budgets
Cost Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor 4.00 32,000$
Indirect material 3.00 24,000
Power 0.50 4,000
Total variable cost 7.50$ 60,000$
Fixed costsDepreciation 12,000$
Insurance 2,000
Total fixed cost
Total overhead costs
Preparing a Flexible BudgetPreparing a Flexible Budget
Fixed costs are expressed as atotal amount that does notchange within the relevant
range of activity.
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Preparing a Flexible BudgetPreparing a Flexible Budget
Variable Total Flexible Budgets
Cost Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor 4.00 32,000$
Indirect material 3.00 24,000
Power 0.50 4,000
Total variable cost 7.50$ 60,000$
Fixed costsDepreciation 12,000$ 12,000$
Insurance 2,000 2,000
Total fixed cost 14,000$
Total overhead costs 74,000$
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Preparing a Flexible BudgetPreparing a Flexible Budget
Variable Total Flexible Budgets
Cost Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor 4.00 32,000$ 40,000$ 48,000$
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost 7.50$ 60,000$ 75,000$ 90,000$
Fixed costsDepreciation 12,000$ 12,000$ 12,000$ 12,000$
Insurance 2,000 2,000 2,000 2,000
Total fixed cost 14,000$ 14,000$ 14,000$
Total overhead costs 74,000$ 89,000$ 104,000$
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Preparing a Flexible BudgetPreparing a Flexible Budget
Variable Total Flexible Budgets
Cost Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor 4.00 32,000$ 40,000$ 48,000$
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost 7.50$ 60,000$ 75,000$ 90,000$
Fixed costsDepreciation 12,000$ 12,000$ 12,000$ 12,000$
Insurance 2,000 2,000 2,000 2,000
Total fixed cost 14,000$ 14,000$ 14,000$
Total overhead costs 74,000$ 89,000$ 104,000$
Note: There is no flexin the fixed costs.
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Preparing a Flexible BudgetPreparing a Flexible Budget
Variable Total Flexible Budgets
Cost Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costs
Indirect labor 4.00 32,000$ 40,000$ 48,000$
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost 7.50$ 60,000$ 75,000$ 90,000$
Fixed costsDepreciation 12,000$ 12,000$ 12,000$ 12,000$
Insurance 2,000 2,000 2,000 2,000
Total fixed cost 14,000$ 14,000$ 14,000$
Total overhead costs 74,000$ 89,000$ 104,000$
Budgeted variable Totaloverhead cost per activity
activity unit units
+Budgeted fixed
overhead cost
Total budgetedoverhead cost =
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Flexible BudgetFlexible BudgetPerformance ReportPerformance Report
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Flexible BudgetFlexible BudgetPerformance ReportPerformance Report
Variable Total
Cost Fixed Flexible Actual
Per Hour Costs Budget Results Variances
Machine hours 8,000 0
Variable costs
Indirect labor 4.00$ 34,000$
Indirect material 3.00 25,500
Power 0.50 3,800
Total variable costs 7.50$ 63,300$
Fixed ExpensesDepreciation 12,000$ 12,000$
Insurance 2,000 2,000
Total fixed costs 14,000$
Total overhead costs 77,300$
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Flexible BudgetFlexible BudgetPerformance ReportPerformance Report
Variable Total
Cost Fixed Flexible Actual
Per Hour Costs Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs
Indirect labor 4.00$ 34,000$
Indirect material 3.00 25,500
Power 0.50 3,800
Total variable costs 7.50$ 63,300$
Fixed ExpensesDepreciation 12,000$ 12,000$
Insurance 2,000 2,000
Total fixed costs 14,000$
Total overhead costs 77,300$
Flexible budget isprepared for the
same activity level
(8,000 hours) asactually achieved.
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Flexible BudgetFlexible BudgetPerformance ReportPerformance Report
Variable Total
Cost Fixed Flexible Actual
Per Hour Costs Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs
Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U
Indirect material 3.00 24,000 25,500 1,500 U
Power 0.50 4,000 3,800 200 F
Total variable costs 7.50$ 60,000$ 63,300$ $ 3,300 U
Fixed ExpensesDepreciation 12,000$ 12,000$ 12,000$ 0
Insurance 2,000 2,000 2,000 0
Total fixed costs 14,000$ 14,000$ 0
Total overhead costs 74,000$ 77,300$ $ 3,300 U
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Flexible BudgetFlexible BudgetPerformance ReportPerformance Report
Variable Total
Cost Fixed Flexible Actual
Per Hour Costs Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs
Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U
Indirect material 3.00 24,000 25,500 1,500 U
Power 0.50 4,000 3,800 200 F
Total variable costs 7.50$ 60,000$ 63,300$ $ 3,300 U
Fixed ExpensesDepreciation 12,000$ 12,000$ 12,000$ 0
Insurance 2,000 2,000 2,000 0
Total fixed costs 14,000$ 14,000$ 0
Total overhead costs 74,000$ 77,300$ $ 3,300 U
Indirect labor andindirect material have
unfavorable variancesbecause actual costs
are more than theflexible budget costs.
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Flexible BudgetFlexible BudgetPerformance ReportPerformance Report
Variable Total
Cost Fixed Flexible Actual
Per Hour Costs Budget Results Variances
Machine hours 8,000 8,000 0
Variable costs
Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U
Indirect material 3.00 24,000 25,500 1,500 U
Power 0.50 4,000 3,800 200 F
Total variable costs 7.50$ 60,000$ 63,300$ $ 3,300 U
Fixed ExpensesDepreciation 12,000$ 12,000$ 12,000$ 0
Insurance 2,000 2,000 2,000 0
Total fixed costs 14,000$ 14,000$ 0
Total overhead costs 74,000$ 77,300$ $ 3,300 U
Power has a favorablevariance because the
actual cost is less thanthe flexible budget cost.
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Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
LearningObjective
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LearningObjective
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Overhead Application in aOverhead Application in aStandard Costing SystemStandard Costing System
Actual Applied Appliedoverhead overhead: overhead:
Actual hours Actual hours
x x
Predetermined Predetermined
overhead rate overhead rate
Difference lies in the
quantity of hours used.
Actual Applied Applied
overhead overhead: overhead:
Standard Standard
allowed hours allowed hours
x x
Predetermined Predeterminedoverhead rate overhead rate
Normal Costing
Manufacturing Overhead Work-in-Process Inventory
Manufacturing Overhead Work-in-Process Inventory
Standard Costing
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Overhead Application in aOverhead Application in aStandard Costing SystemStandard Costing System
Budgeted
Overhead
Variable . . . . 60,000$ * . . . . . . . . . 8,000 machine hours . . . . . . . . 7.50$ per process hourFixed . . . . . . 14,000 * . . . . . . . . . 8,000 machine hours . . . . . . . . 1.75 per process hour
Total . . . . . . 74,000$ . . . . . . . . . 8,000 machine hours . . . . . . . . 9.25$ per process hour
* From the flexible budget for planned activity of 8,000 machine hours
Planned
Monthly Activity
Predetermined
Overhead Rate
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LearningObjective
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LearningObjective
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Choice of Activity MeasureChoice of Activity Measure
Variable overhead and the activitymeasure should vary in a similarpattern.
Identify variable overhead costdrivers.
Examples: machine hours, laborhours, process time.
Dollar measures should be avoidedas they are subject to price-levelchanges.
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LearningObjective
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LearningObjective
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Cost Management UsingCost Management UsingOverhead Cost VariancesOverhead Cost Variances
L
ets turn our attentionto the computation ofoverhead cost variances.
We will begin withvariable overhead.
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Spending
Variance
Efficiency
Variance
AH SVRAH AR
AH = Actual Hours of ActivityAR = Actual Variable Overhead RateSVR = Standard Variable Overhead RateSH = Standard Hours Allowed
SH SVR
Actual Flexible Budget Flexible BudgetVariable for Variable for VariableOverhead Overhead at Overhead atIncurred Actual Hours Standard Hours
Variable Overhead Variances
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Spending
Variance
Efficiency
Variance
AH SVRAH AR SH SVR
Actual Flexible Budget Flexible BudgetVariable for Variable for VariableOverhead Overhead at Overhead atIncurred Actual Hours Standard Hours
Variable Overhead Variances
Spending variance = AH(AR - SVR)
Efficiency variance = SVR(AH - SH)
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ColaCos actual production for the periodrequired 3,200 standard machine hours.
Actual variable overhead incurred for theperiod was $6,740. Actual machine hoursworked were 3,300.
Compute the variable overhead spending andefficiency variances.
Variable Overhead VariancesVariable Overhead Variances ExampleExample
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ColaCo prepared this budget for overhead:
Variable Overhead VariancesVariable Overhead Variances ExampleExample
Budgeted variable Totaloverhead cost per x activity
activity unit units+
Budgeted fixedoverhead cost
Total budgeted
overhead cost =
Total budgetedoverhead cost =
$2.00 permachine
hour
Totalmachine
hours+ $9,000
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3,300 hours 3,200 hours $2.00 per hour $2.00 per hour
Spending variance$140 unfavorable
Efficiency variance$200 unfavorable
Actual Flexible Budget Flexible BudgetVariable for Variable for VariableOverhead Overhead at Overhead atIncurred Actual Hours Standard Hours
$6,740 $6,600 $6,400
Variable Overhead VariancesVariable Overhead Variances ExampleExample
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3,300 hours 3,200 hours $2.00 per hour $2.00 per hour
Actual Flexible Budget Flexible BudgetVariable for Variable for VariableOverhead Overhead at Overhead atIncurred Actual Hours Standard Hours
$6,740 $6,600 $6,400
Variable Overhead VariancesVariable Overhead Variances ExampleExample
The $140 unfavorable spending variance and the $200unfavorable efficiency variance result in a $340
unfavorable flexible budget variance.
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Variable Overhead VariancesVariable Overhead Variances AACloserLookCloserLook
Spending Variance Efficiency Variance
Results from paying moreor less than expected for
overhead items and fromexcessive usage of
overhead items.
A function of theselected cost driver.
It does not reflectoverhead control.
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Fixed OverheadFixed Overhead
Now lets turnour attention tofixed overhead.
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BudgetVariance
VolumeVariance
PFOHR = Predetermined Fixed Overhead RateSH = Standard Hours Allowed
SH PFOHR
Actual Fixed Fixed FixedOverhead Overhead OverheadIncurred Budget Applied
Fixed Overhead Variances
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PFOHR =
Applied Fixed Overhead = PFOHR Standard Hours
Budgeted Fixed Overhead
Planned Activity in Hours
Recall that fixed overhead costs are appliedto products and services using a
predetermined fixed overhead rate
(PFOHR):
Fixed OverheadFixed Overhead
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ColaCos actual production required 3,200standard machine hours. Actual fixed
overhead was $8,450.
Compute the fixed overhead budget andvolume variances.
Fixed Overhead VariancesFixed Overhead Variances ExampleExample
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3,200 hours
$3.00 per hour
Fixed Overhead VariancesFixed Overhead Variances ExampleExample
Actual Fixed Fixed FixedOverhead Overhead OverheadIncurred Budget Applied
$8,450 $9,000 $9,600
Budget variance$550 favorable
Volume variance$600 (neither favorable
nor unfavorable)
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Fixed Overhead VariancesFixed Overhead Variances
Lets look at a graph
showing fixedoverhead variances.We will use ColaCos
numbers from theprevious example.
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Fixed Overhead VariancesFixed Overhead Variances A CloserLookA CloserLook
Budget Variance Volume Variance
Results from paying moreor less than expected for
overhead items.
Results from the inabilityto operate at the activity
level planned for the period.
Has no significance forcost control.
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Volume
Cost
$9,600 applied fixed OH
$9,000 budgeted fixed OH
3,200 machine hours $3.00 fixed overhead rate
Fixed Overhead VariancesFixed Overhead Variances
{$600
VolumeVariance
{$550FavorableBudgetVariance
$8,450actual
fixed OH
3,200Standard
Hours
3,000 HoursPlannedActivity
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LearningObjective
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LearningObjective
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Overhead Cost Performance ReportOverhead Cost Performance Report
Variable costs:
Indirect material:
Wax
Plastic wrap
Paper productsMisc. supplies
Indirect labor:
Maintenance
Janitorial
Utilities:
Electricity
Natural gas
Water
Total variable cost
Fixed costs:
Indirect labor:InspectionProduction supervisor
Set upDepreciation:
EquipmentInsuranceProperty taxesTotal fixed cost
Total overhead cost
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LearningObjective
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LearningObjective
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ActivityActivity--Based Flexible BudgetBased Flexible Budget
Variable Total Flexible Budgets
Cost Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costsIndirect labor 4.00 32,000$ 40,000$ 48,000$
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost 7.50$ 60,000$ 75,000$ 90,000$
Fixed costsDepreciation 12,000$ 12,000$ 12,000$ 12,000$
Insurance 2,000 2,000 2,000 2,000
Total fixed cost 14,000$ 14,000$ 14,000$
Total overhead costs 74,000$ 89,000$ 104,000$
The Cheese Co. flexiblebudget is based on a singlecost driver, machine hours
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ActivityActivity--Based Flexible BudgetBased Flexible Budget
Variable Total Flexible Budgets
Cost Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Machine hours 8,000 10,000 12,000
Variable costsIndirect labor 4.00 32,000$ 40,000$ 48,000$
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost 7.50$ 60,000$ 75,000$ 90,000$
Fixed costsDepreciation 12,000$ 12,000$ 12,000$ 12,000$
Insurance 2,000 2,000 2,000 2,000
Total fixed cost 14,000$ 14,000$ 14,000$
Total overhead costs 74,000$ 89,000$ 104,000$
If different cost drivers are identified for thedifferent variable costs, an activity-based flexible
budget should be prepared with different costformulas based on the different drivers.
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LearningObjective
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LearningObjective
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Standard Costs and Product CostingStandard Costs and Product Costing
Actual Applied Applied
overhead overhead: overhead:
Standard Standard
allowed hours allowed hours
x x
Predetermined Predeterminedoverhead rate overhead rate
Manufacturing Overhead Work-in-Process Inventory
Standard Costing
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Standard Costs and Product CostingStandard Costs and Product Costing
Actual Applied Balance (1) Balance (2)
overhead overhead: Actual Applied
Standard overhead overhead
allowed hours greater than greater thanx Applied Actual
Predetermined overhead overhead
overhead rate
Balance (1) Balance (2)
Balance (2)
Balance (1)
Manufacturing Overhead Cost of Goods SoldDisposition ofVariances
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LearningObjective
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LearningObjective
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A G l M d l f V iA G l M d l f V i
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A General Model for VarianceA General Model for VarianceAnalysisAnalysis
Actual Quantity Actual Quantity Standard Quantity
Actual Price Standard Price Standard Price
Price Variance Quantity Variance
Materials price variance Materials quantity varianceLabor rate variance Labor efficiency varianceVariable overhead Variable overheadspending variance efficiency variance
AQ(AP - SP) SP(AQ - SQ)
AQ = Actual Quantity SP = Standard PriceAP = Actual Price SQ = Standard Quantity
A G l M d l f V iA G l M d l f V i
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A General Model for VarianceA General Model for VarianceAnalysisAnalysis
Actual Sales Volume Actual Sales Volume Budgeted Sales Volume
Actual Sales Price Budgeted Sales Price Budgeted Sales Price
Sales Price Variance Sales Volume Variance
ASV(ASP - BSP) BSP(ASV - BSV)
ASV = Actual Sales Volume BSP = Budgeted Sales PriceASP = Actual Sales Price BSV = Budgeted Sales Volume
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End of Chapter 11End of Chapter 11
Im here to yourbudget. Are you ready to
ante up?