ABC Essentials Become Familiar with Terminology Emphasize Basic Concepts Behind Activity-Based Cost and ABM Apply concepts thru Class Exercises 2 Managerial Accounting Essentials This introductory course in Managerial Accounting with an emphasis on Activity-Based Cost and Management is based on the textbook, Management Accounting, 2 ed., written by Anthony A. Atkinson, Rajiv D. Banker, Robert S. Kaplan, and S. Mark Young. Concepts and terms from Chapters 1 through 5 plus 9 and 10 will be highlighted for this course. Conventions used throughout the course: - indicates a definition - indicates a key concept or equation 3 Management Accounting Goals Improve the quality of operations Lower the cost of operations Increase the responsiveness of operations for customer needs #1 - Management Accounting Information that Creates Value Differences between financial and management accounting The informational needs of management accounting Activities as the primary focus for measuring and managing performance 5 Basic Features of Accounting 6 Management Accounting System Operational and Financial Data Management Accounting Information INPUTS PROCESSING OUTPUTS 7 Management Accounting The process of identifying, measuring, reporting and analyzing financial as well as operating information for the internal users regarding the economic condition of an organization. 8 Comparisons of the Systems Managerial Accounting Internal constituencies Feedback and control Current, future oriented Process driven Financial, operational, physical measures More subjective More drill-down Financial Accounting External constituencies Past performance Historically oriented Rules driven Only financial measures Objective Highly aggregate 9 The Various Levels for Reporting Senior Executives Upper/ Middle Management Upper/ Middle Management Operationa l 10 Operational Level Level of detail Disaggregate Types Inputs used Outputs produced Quality of service or production process Very current Frequency V ery Frequent 11 Middle/Upper Management Level of detail More aggregate Types Resources used Efficiency Quality of work performed Profitability Current and future Frequency Frequent 12 Senior Executives Level of detail Highly aggregate Types Profitability Market opportunities and threats Customer loyalty and satisfaction Technological innovations Current and future Frequency Less Frequent 13 Functions of ABC Customer Costing Operational Control Product Costing Management Control 14 Functions of ABC 15 Foundation of ABC DuPont Corporation Operating budget Capital budget Return on investment ROI = Operating Income/Investment DuPont Corporation Operating budget Capital budget Return on investment ROI = Operating Income/Investment General Motors Decentralized responsibility Centralized control Flexible budget General Motors Decentralized responsibility Centralized control Flexible budget Circa 1920 After 1925, Modern Day Accounting Reporting Standards were established by the Securities Exchange Commission. 16 Flexible Budget A forecast of what expenses should have been, given the actual volume and mix of production and sales. Flexible budgets recast cost targets in the planned or master budget to reflect the actual level of production. This allows comparisons of actual results to targets based on the achieved level of production. 17 Flexible Budgets Time Dollars Budget Timephased Flexible (Time ) Flexible Budget Unfavorable Cost Variance Favorable Cost Variance Look Familiar? (Circa 1925) 18 Cost Performance Comparison of: Actuals Budget ETC EV Modern Flexible Budgeting 19 Cost Performance Terms Data Elements: Total Budget = Budget at Completion Budget = Budget to Date Performance = Performance to Date (EV) Expenses = Actual Cost to Date ETC = Estimate to Complete EAC = Estimate at Completion 20 Cost Performance Terms Analysis: CV = Cost Variance SV = Schedule Variance VAC = Variance at Completion SPI = Schedule Performance Index CPI = Cost Performance Index IEAC = Independent Estimate At Complete These calculations are used to analyze the performance of the operation. 21 Cost Performance Calculations 22 Cost Performance Example A fan manufacturer implements cost performance techniques to analyze the progress of the operation. The Initial Plan for production: Make 1,000 Fans over 50 days Steady rate of 20 fans per day Budgeted cost per fan is $50 Total project budget is $50,000 23 Cost Performance Example Status of fans after 10 days: Budget to Date: $10,000 Performance to Date: $7,500 Actual Cost to Date: $9,000 ETC $2,500 EAC $11,500 VAC $1,500 Schedule Variance: ($2,500) Cost Variance ($1,500) SPI.75 (less than one) CPI.833 This effort is behind schedule and over budget as indicated by the SV and CV 24 Projecting Revenue and Expenses Time Dollars Budget Timephased Flexible (Time ) Flexible Budget } Unfavorable Cost Variance } Favorable Cost Variance ROI Sales/Revenue Look Familiar? (Circa 1925) 25 Actual Cost Data Elements in ABC Expenses BCWS - Budgeted Cost of Work Scheduled BCWP - Budgeted Cost of Work Performed ACWP - Actual Cost of Work Performed ETC - Estimate to Complete EAC - Est. at Complete Revenues RAC - Revenue at Complete RP - Revenue Planned RBTD - Revenue Billed to Date RCTD - Rev.e Collected to Date CV - Cost Variance (BCWP-ACWP) SV - Schedule Var. (BCWP-BCWS) Profit - RCTD - ACWP Expenses Cost vs. Revenue 26 Service Industries and Companies 27 Activities Represent the verbs of a company Are Product-Oriented Work output will have a discrete unit of measurement These verbs consume an organizations resources and employees 28 Activity-Based Costing A procedure that measures the costs of objects, such as products, services and customers. Activity-based costing (ABC) first assigns resource costs to the activities performed by the organization. Then activity costs are assigned to the products, customers, and services that benefit from or are creating the demand for the activities. 29 Activity-Based Management The management processes that use the information provided by an activity-based cost analysis to improve organizational profitability. Activity-based management (ABM) includes performing activities more efficiently, eliminating the need to perform certain activities that do not add value for the customers, improving the design of products, and developing better relationships with customers and suppliers. The goal of ABM is to enable customer needs to be satisfied while making fewer demands on organizational resources. 30 Produce a product Indirect contact with customers Have inventory Quality to build into production process Provide a service, generally no product More direct contact with customers No inventory, per se Quality hard to control in advance Manufacturing vs Service Function Service Organization Manufacturing Organization 31 Continuous Improvement Empowering employees to continually problem-solve and search for ways to improve organizational processes. 32 Employee Empowerment Managers give employees who are closest to operating processes, customers, and suppliers the rights to make decisions. Employees are encouraged to solve problems and devise creative new approaches for performing work and satisfying customers. 33 Employee Empowerment Enables Sharing pertinent financial information with operators allows them to do the following: Identify the opportunities for significant cost reduction Set priorities for improvement projects Make tradeoffs among alternative ways to improve operations Evaluate proposed investments to improve operations Assess the consequences of their improvement activities 34 Total Quality Management A philosophy that attempts to eliminate all defects, waste, and activities that do not add value to customers. 35 Balanced Scorecard A multi-dimensional measurement system that translates an organizations mission and strategy into performance measures. 36 Balanced Business Scorecard Financial Perspective How do we look to our shareholders? Business Process What business processes are the value drivers? Organization Learning Are we able to sustain innovations, change and improvement? Vision & Strategy Customer Perspective How do we look to our customers? 37 The Internal Business Process Identify the Market Create the product/ service offering Build the product/ service Deliver the product/ service Service the Customer Customer Need Identified Customer Need Satisfied Innovation Process Operations Process Post-Sale Service Process 38 Behavioral Implications Information is never neutral People react to measurements People familiar with old systems often resist new systems Unexpected actions may result as employees respond to new performance measures Behavioral Implications of Management Accounting Information: 39 Applying the Concepts Difference between Financial & Managerial Accounting Exercise #1 What are the advantages and disadvantages of having separate departments for financial accounting and management accounting? 40 Applying the Concepts Difference between Financial & Managerial Accounting Exercise #1 What are the advantages and disadvantages of having separate departments for financial accounting and management accounting? The principal advantage is that these quite different functions can be performed by employees who are dedicated to their particular tasks. A particular advantage for managerial accountants is not having to follow GAAP. Separate departments may result in information prepared for internal use that may not immediately compatible with external reporting requirements. 41 Applying the Concepts Difference between Financial & Managerial Accounting Exercise #1 (continued) Many German companies have their management accounting department as part of the manufacturing operations group rather than as part of the corporate finance department. These German companies operate two separate accounting departments. One performs financial accounting functions for shareholders and tax authorities; the other maintains and operates the costing system for manufacturing operations. 42 Applying the Concepts Employee Empowerment Exercise #2 Information for Employee Empowerment A U.S. automobile components plant had recently been reorganized so that quality and employee teamwork were to be the guiding principles for all managers and workers. Comments by participants included: Production worker - In the old production environment, we were not paid to think. The foreman told us what to do, and we did it even if we knew he was wrong. Plant Controller - In the traditional factories, the financial system viewed people as variable costs. Our production people are now viewed as problem solvers, not as variable costs. 43 Applying the Concepts Employee Empowerment Exercise #2 1. What information needs did the production workers have in the old environment? 2. What information do you recommend be supplied to the production workers in the new environment that emphasizes quality, defect reduction, problem-solving, and teamwork? 44 Applying the Concepts Employee Empowerment Exercise #2 (continued) 1. What information needs did the production workers have in the old environment? Virtually none, they did what they were told. 2. What information do you recommend be supplied to the production workers in the new environment that emphasizes quality, defect reduction, problem-solving, and teamwork? They need information after each batch: defects, scrap, downtime, etc. They also need information on yields and capacity, trend information, etc. #2 - The Organization The organization as a sequence of activities in a value chain The role of the customer in defining focus The nature of value-added and nonvalue-added activities 46 Value Chain A sequence of activities that creates a good or service in which each step of the sequence should add something that the customer values to the product. Customer Product Activities 47 Key Elements of the Value Chain (3) Output Activities Selling, shipping service (2) Processing Activities Making, moving, storing inspecting (1) Input Activities Product design, process design, purchasing, receiving, hiring, training (4) Administrative Activities Personnel, legal, finance, research, accounting 48 Stakeholders Those people, groups, or institutions who define an organizations success or who can affect its ability to achieve its objectives. 49 Stakeholders and the Value Chain process objectives relating to customers value chain/process constraints effects of value chain design on stakeholders other than customers Stakeholder Objectives: customers employees suppliers owners community Organization Objectives Organization Control Customer Satisfaction with Products Process Control Value chain design and operation Domain of Management Accounting the organizations primary values compare actual with plan effects of customer satisfaction on other stakeholders compare actual with plan products 50 Stakeholder Groups Each group makes contributions to the organization, has requirements the organization must meet, and has an effect on the value chain EmployeesCommunity CustomersSuppliers Owners 51 Process Control Assesses the operating performance of the value chain in meeting customer requirements. Focuses on short-term, is often continuous. Measures short-term performance against short-run targets or standards. 52 Critical Success Factors Elements of performance required for an organizations success, for example, for customers, service, quality, and cost; for employees, job satisfaction and safety; for partners and owners, an adequate return on investment; on the community, conformance to laws. 53 Critical Success Factors Service Quality Cost Safety Job Satisfactio n Conformance to Laws CustomerEmployeeCommunity 54 Service The products tangible and intangible features promised to the customer; service is also known as value in use. 55 Quality The difference between the promised and the realized level of service; conformance to specifications. 56 Service and Quality What the customer wants What the customer is promised What the customer is given The Service GapThe Quality Gap 57 Customer Performance 58 Qualities of Performance Effectiveness Ability to accomplish objectives Determined by process design Efficiency Ability to use fewest possible resources to accomplish objectives Determined by process design and how the process operates 59 Critical Performance Indicators Consider Activities from the customers perspective Evaluate using customer-validated measures Are comprehensive Provide Feedback 60 Customer Validation Inputs Resources used in activities Outcomes How the customer values the result of the activity Process Activities which transform resources into outputs Outputs Physical measures of activity 61 Inputs, Outputs, and Outcomes 62 Signals A warning signal triggers an investigation into the cause of an underlying problem A diagnostic signal provides evidence of the nature of an underlying process problem and may suggest a way to deal with it 63 Control The set of methods and tools that organization members use to keep the organization on track toward achieving its objectives. 64 Control - Accounting the Old Way Emphasis on potential or past performance encourages working harder and faster. Associated with Managing by the Numbers No data ownership by users 65 Control through ABC/M Control may be exercised by: Ensuring compliance with standard operating procedures Motivating people to be creative in meeting customer objectives Data ownership by users 66 Managing by the Numbers Problems: Ineffective Assumes cost to be the only relevant measure of performance Does not recognize the reasons for costs in an organization 67 Control - Accounting Under ABC Emphasis on improving processes and eliminating things that do not improve the product encourages working smarter. 68 Cost Control Under ABM Activity-Based Management approaches costs by studying the need, effectiveness, and efficiency of activities which create the costs. 69 How Activities Create Cost Activities UndertakenResources UsedCosts Activity 1 Value added, inefficient Activity 2 Nonvalue added, efficient Activity 3 Nonvalue added, ineffcient Activity 4 Value added, efficient Materials Labor Equipment $ 70 Value-Added Activities An activity that, if eliminated, in the long run would reduce the products or services value to the customer. 71 NonValue-Added Activity An activity that presents the opportunity for costs reduction without reducing the products or services potential value to the customer. 72 Steps in Activity Analysis (1) Identify process activities (2) Chart the existing process (3) Classify all activities (4) Continuously improve all activities and plan to eliminate nonvalue-added activities 73 Applying the Concepts Product Service Features Exercise #1 For each of the following products, what are the three most important elements of service: 1television set 2visit to the doctor 3trip on an airplane 74 Applying the Concepts Product Service Features Exercise #1 For each of the following products, what are the three most important elements of service: 1television set Warranty, courtesy, delivery 2visit to the doctor Waiting time, style, diagnosis 3trip on an airplane Comfort, courtesy, meals, on-time 75 Applying the Concepts The Elements of Quality Exercise #2 For each of the following products, suggest three measures of quality: 1television set 2visit to the doctor 3trip on an airplane 76 Applying the Concepts The Elements of Quality Exercise #2 For each of the following products, suggest three measures of quality: 1television setPerformance, service number 2visit to the doctorRecovery, # of visits, complaints 3trip on an airplane# of complaints, safety #3 - Cost Concepts Understand the difference between direct and indirect costs Classification of costs Understand and identify cost drivers Determine standard costs and understand the limitations of that system 78 Activity Cost Driver Unit of measurement for the level (or quantity) of the activity performed. 79 Types of Production Activities Unit-related Batch-related Product-sustaining Facility-sustaining 80 Unit Related Activities Examining patients in a doctors office Inspecting products Baling hay Cost Drivers Number of patients seen Number of units inspected Number of bales baled 81 Batch-Related Activities Machine setup First-item inspection Purchase ordering Materials handling Production scheduling Cost Drivers Number of setups Number of inspections Number of orders Number of material moves Number of production runs 82 Product-Sustaining Activities Product design Parts administration Engineering Expediting production orders Cost Drivers Number of products Number of parts Number of engineering change orders Number of orders produced 83 Facility-Sustaining Activities Plant management Accounting and personnel Housekeeping Cost Drivers Square feet of space Number of workers Number of rooms cleaned 84 Functional Cost Classifications 85 Direct Costs Those costs easily traced to the product such as : Direct Material and Direct Labor Are typically value-added activities. 86 Direct Cost Equation where C = cost of input resource P = price per unit of resource Q = quantity (number of units) of resource C = P * Q 87 Indirect Costs Those costs not easily identified with individual products - also referred to as overhead or burden. Often nonvalue-added activities. 88 Service Cost Structure Today Direct Labor still a majority of the costs Few Direct Materials Indirect Labor can be considerable 89 Manufacture Cost Structure Today Direct Labor only a small portion of manufacturing costs Direct materials still important (40% - 60%) in some plants Overhead costs are proportionally higher than in the past 90 Basic Cost Driver Equation where C = cost of input resource R = output rate for the activity X = the surrogate cost driver measure for the activity (activity driver second stage) C = R * X 91 Activity Overhead Rate Equation where C = cost of input resource R = output rate for the activity X = the surrogate cost driver measure for the activity (activity driver second stage) R = C/X 92 Overhead Costs and Activities Total Overhead Costs are a function of all Activities =C 1 + C 2 + C 3 + C 4 + C 5 =R 1 X 1 + R 2 X 2 + R 3 X 3 + R 4 X 4 + R 5 X 5 93 Determining Overhead Rates Identify the activities performed Determine the cost of performing each activity Identify the cost driver for each activity Determine the number of units of the cost driver made available by the resources committed to each activity Divide the activity cost by the number of cost driver units made available to determine the activity overhead rate 94 Standard Costs Benchmarks based on standards established in advance for: The quantity of activity resources that should be consumed by each unit of output The price of these resources 95 Uses of Standard Cost Systems Estimate product costs Budget for costs and expenditures Control costs relative to standards 96 Level of Standards Standards should be efficient and attainable, depending on how standards influence the behavior of workers and managers whose performance is evaluated relative to the standards. Type of Standards Ideal Practical Actual 97 Limits on Standard-Only Cost Usefulness is restricted largely to settings in which the production technology is stable and the number of business changes taking place is small Over reliance on managing with a standard cost system creates a mind-set of meeting the standards All too often the standards are based on ideal not practical systems 98 Applying the Concepts Determining Activity Cost Driver Rates Exercise #1 What five steps must be performed to determine the activity cost driver rates? 99 Applying the Concepts Determining Activity Cost Driver Rates Exercise #1 What five steps must be performed to determine the activity cost driver rates? 1. Identify the activities performed by organizations. 2. Determine cost of performing each activity. 3. Identify cost driver for each activity. 4. Determine the number of units of the cost driver made available by the resources committed to each activity. 5. Divide activity cost by activity cost driver units to obtain activity cost driver rate. 100 Applying the Concepts Cost Classification by activity type Exercise #2 Classify the following costs as unit-related, batch-related, product-sustaining, or facility-sustaining activity costs: Packing labor wages Materials-handling labor wages Part administrators salaries Plant management salaries Production scheduling staff salaries Equipment maintenance Property taxes Production expediters salaries Insurance for plant facility 101 Applying the Concepts Cost Classification by activity type Exercise #2 Classify the following costs as unit-related, batch-related, product-sustaining, or facility-sustaining activity costs: Packing labor wages UNIT RELATED Materials-handling labor wages BATCH RELATED Part administrators salaries PRODUCT SUSTAINING Plant management salaries FACILITY SUSTAINING Production scheduling staff salary BATCH RELATED Equipment maintenance UNIT RELATED Property taxes FACILITY SUSTAINING Production expediters salaries PRODUCT SUSTAINING Insurance for plant facility FACILITY SUSTAINING #4 - Cost Behavior Identify the difference between fixed and variable costs How commitment and usage of activity resources influence cost variability Understand why activity costs are variable in the long run 103 The Relevance of Cost Behavior Cost behavior, or how costs behave in response to changes in production volume, is a concern for decision makers in almost all industries. 104 Fixed Costs Graph 0 5,000 10,000 15,000 $20, Quarterly Production (Q) in thousands of gallons Quarterly Fixed Costs (FC) FC = $10,000 105 Fixed Costs per Unit of Volume $ Quarterly Production (Q) in thousands of gallons Quarterly Fixed Costs per Gallon (FC/Q) $ 106 Variable Costs Graph Quarterly Variable Costs (VC) Slope = VC = $ * Q $15,360 $19,200 $23,040 $26,880 $30, ,000 20,000 30,000 $40, ,000 Quarterly Production (Q) in thousands of gallons Quarterly Variable Costs (VC) in dollars 107 Variable Costs per Unit Volume $ ,000 Quarterly Production (Q) in thousands of gallons Quarterly Variable Costs per Gallon (VC/Q) VC/Q = $ per gallon 108 Mixed Costs Costs comprised of both fixed and variable cost components. 109 Mixed Costs C = $10,000+($ * Q) Slope = $ ,000 20,000 30,000 40, ,000 Quarterly Production (Q) in thousands of gallons Quarterly Costs (C) $50,000 $25,360 $29,200 $33,040 $36,880 $40,720 Variable cost Fixed cost 110 Total Cost Equation where C = total cost F = fixed costs V = variable cost rate Q = quantity of production C = F + VQ 111 Total Cost Equation Total Cost may also be represented by where C = total cost R = output rate for the activity X = cost driver measure for the activity C = R 1 X 1 + R 2 X 2 + R 3 X 3 + R 4 X 4 + R 5 X5 112 Determine Variable Cost Rate If X 1, X 2, and X 3 are cost drivers that vary with production volume, then Total Variable Costs = R 1 X 1 + R 2 X 2 + R 3 X 3 And, the variable cost rate, V, can be determined V = R 1 X 1 + R 2 X 2 + R 3 X 3 Q 113 Determine Total Fixed Costs And, assuming X4 and X5 are cost drivers that are independent of Q, then Total Fixed Cost = R 4 X 4 + R 5 X 5 114 Economic Framework Cost curve Economies of scale Capacity of constraints Diseconomies of scale Relevant range 115 Cost Curve Graph V 0 Production Level (Q) Total Cost (C) F C = C(Q) Relevant Range C = F + (VQ) 116 Step Fixed Costs Graph Production Level (Q) Cost (C) Relevant Range 117 Step Variable Costs Graph Production Level (Q) Cost (C) Relevant Range 118 Profit = Revenues - Costs = (P * Q) - (F + V * Q) or = (P - V) * Q - F where F = fixed cost Q = production level in units V = variable cost rate per unit P = selling price per unit 119 Breakeven Analysis Breakeven analysis involves determining the level of production at which the profit resulting from one option is at least as large as the profit resulting from an alternative option. 120 Determining the Breakeven Point Breakeven point (in units) = Fixed costs / Contribution margin per unit or Q 0 = F / (P - V) where Q 0 = Quantity of production in units F = Fixed Costs (P - V) = Contribution margin per unit 121 Breakeven Chart Production and Sales Volume 0 Costs and Revenues Variable Costs Fixed Costs Total Sales Revenues Total Costs Breakeven Point Profit Loss 122 Production Volume at Target Profit where Q T = Target quantity of production in units F = Fixed Costs T = Target profit (P-V) = Contribution margin per unit Production volume = (Fixed costs + Target profit)/Contribution margin/unit or Q T = (F+T) / (P - V) 123 Normal Cost Equation Regular cost of providing capacity Capacity made available Normal Unit Cost = 124 Refined Activity Cost Driver Rate Rate = Activity Costs Number of units of the activity cost driver where The activity costs by the regular cost only to provide the normal capacity of activity resources and The number of units of the cost driver represent the capacity made available by the resources committed to the activity 125 Support Activity Resource Class Flexible Discretionary Committed 126 Applying the Concepts Classification of cost behavior Exercise #1 Classify each of the following as a variable, fixed, or mixed cost: Salaries of production supervisors Wages of production workers Salary of the chief executive officer Charges for janitorial services Commissions paid to sales personnel Advertising expenses Salaries of billing clerks Electricity used to generate machines Lubricants for machines Maintenance for machines 127 Applying the Concepts Classification of cost behavior Exercise #1 Classify each of the following as a variable, fixed, or mixed cost: Salaries of production supervisorsVARIABLE Wages of production workersVARIABLE Salary of the chief executive officerFIXED Charges for janitorial services FIXED Commissions paid to sales personnelVARIABLE Advertising expenses FIXED Salaries of billing clerksFIXED Electricity used to generate machinesVARIABLE Lubricants for machinesVARIABLE Maintenance for machinesVARIABLE or FIXED 128 Applying the Concepts The effect of management decisions on cost behavior Exercise #2 Why are activity costs more likely to be variable when managers have greater flexibility in adjusting the level of resources committed for the activity? 129 Applying the Concepts The effect of management decisions on cost behavior Exercise #2 Why are activity costs more likely to be variable when managers have greater flexibility in adjusting the level of resources committed for the activity? When the managers have greater flexibility in adjusting the level of resources committed for an activity, they can plan in advance to adjust the level of committed resources to meet anticipated changes in production volume and consequent demand for activity resources. Costs of activity resources are thus adjusted to match short run fluctuations in production levels. #5 - Product Costing Systems Understand the use of multiple cost drivers vs. single cost drivers Evaluate a cost system for product cost distortion Understand the relevance of performing variance analysis 131 Job Bid Sheet 132 Work Authorization Sheet 133 Activity Cost Driver Rate R = Normal activity costs Normal level of cost driver where Normal activity costs are the costs of the resources committed to the particular activity and The normal level of the cost driver is the long-term capacity made available by the amount of resources committed to the activity 134 Cost Pool Each subset of total support costs that can be associated with a distinct cost driver. 135 How Many Cost Pools? A separate cost pool should be used if the productivity of resources is different and if the pattern of demand varies across products The optimal number of cost pools will change over time as an organization changes 136 Materials Requisition Note Note telling the stores department to issue material to the shop floor in order to begin production Translates in summary form to the Job Cost Sheet 137 Timecard Example A form used to record the hours spent by each worker each day or week on different jobs Pertinent summary information translates to the job cost sheet 138 Timecard Example 139 Job Cost Sheet 140 Basic Variance Analysis Variances are differences between actual and estimated costs and are a necessary step for managers who are attempting to understand why a difference occurred. 141 Cost Estimate for 290 Valves 142 First-Level Variance Calculation First-Level Variance = Estimated Costs - Actual Costs 143 Favorable/Unfavorable Variances F Favorable variances signify that actual costs were less than estimated costs. U Unfavorable variances signify that actual costs were greater than estimated costs. 144 First-Level Analysis of Variances 145 Variance Analysis Example 146 Direct Materials Price Variance where AP = Actual price of materials SP = Estimated or standard price of materials AQ = Actual quantity of materials used (AP - SP) * AQ 147 Direct Materials Usage Variance where AQ = Actual quantity of materials used SQ = Estimated or standard quantity of materials required SP = Estimated or standard price of materials (AQ - SQ) * SP 148 Total Direct Materials Variance Usage variance + Price variance = = (AQ - SQ) * SP + (AP - SP) * AQ = (AP * AQ) - (SQ * SP) 149 Second-Level Variance Analysis Further analysis of a first-level variance into efficiency (use) and price variances 150 Cost Cumulative Variance Example 151 Wage Rate Variance where AR = Actual wage rate SR = Estimated or standard wage rate AH = Actual number of direct labor hours (AR - SR) * AH 152 Labor Efficiency Variance where AH = Actual number of direct labor hours SH = Estimated or standard number of direct labor hours SR = Estimated or standard number of direct labor hours (AH - SH) * SR 153 Total Direct Labor Variance Labor Efficiency + Wage Rate = = (AH + SH) * SR + (AR - SR) * AH = (AR * AH) - (SR * SH) 154 Second-Level Variance Analysis Like materials usage variances, direct labor variances can be broken into efficiency and rate variances. What is the significance of the efficiency variances? 155 Comparison of Costing Systems 156 Multistage Process Product Costs Identify the costs of the material input required at various stages Add the estimated conversion costs for all the process stages to the material costs 1 2 157 Applying the Concepts Job costing Exercise #1 What is the source of the information to estimate the cost of materials? 158 Applying the Concepts Job costing Exercise #1 What is the source of the information to estimate the cost of materials? Quantity required is based on standard engineering specifications. Price of each item is obtained from the purchasing department. 159 Applying the Concepts Job costing Exercise #2 What is a cost pool? Why are multiple cost pools required? 160 Applying the Concepts Job costing Exercise #2 What is a cost pool? A cost pool is a portion of the total support costs associated with a DISTINCT cost driver. Why are multiple cost pools required? Multiple cost pools are required when support costs are driven by more than one factor (cost driver).