Budgets and Variances continued Production variances Agenda

Budgets and Variances continued: Production variances

Agenda • • • Return Reichard: recap main points Midterm exam discussion Briefly review production variances Vanguard problem Group work: Example Company

Reichard • IC of 100 plastic rings = $32, CM = $293, or $73 per 100 steel rings on an equivalent basis of 4 steel rings =1 plastic ring. • This assumes a price of $325/100. • Current margins are about 20% on sales (1264/325) or 25% of Full Cost. • If price drops to $82/100 for plastic, profit per 100 rings = $15/100 * 9000 rings = $1350 p. a. on current (equiv) sales volume

Reichard • In fact, the entire market for plastic rings will produce $13, 500 p. a. in profits: less than what Reichard earned on 10% of the steel ring market!!! • Is this any market for Reichard to be in? • Should we bother to compete in plastic? • Where do we go from here? • How many proprietary parts do we have?

Midterm Exam • The exam has five questions. • Question 1: Cost estimation - regression (a make or buy decision) • Question 2: Production cost variances (compute 11 variances) • Question 3: Manufacturing Costs and Accounts • Question 4: Cost-volume-profit - minimum SP • Question 5: Identifying relevant costs and revenues

Midterm self-evaluation of participation: • Get a copy of the form from the homepage: Go to “Schedule of Work, ” scroll to “Midterm Exam”, click on “self-evaluation” • The form contains some grading criteria; also use the criteria attached to the syllabus. • I have my grades already recorded. I record grades after each class. • I’ll write my midterm grade on your form and hand it back to you with your exam.

Review of Tuesday’s discussion • Variances are departures from budget expectations - they are performance evaluation measures. • Each one measures a favorable or unfavorable change in (budgeted) net income due to some departure from planned sales and production. • They do not, themselves, provide answers they trigger questions.

Review: What information do variances convey? • What do activity variances convey? • What do price variances convey? – Material and labor (price) – Variable overhead (spending) – Fixed overhead (budget) • What do efficiency variances convey? • What do production volume variances convey?

Variance computations: • Price variances: Find the difference between the budgeted and the actual prices and multiply the difference by the actual number of units of the input consumed/purchased. • Quantity/efficiency variances: Find the difference between the actual number of units of the input consumed and the number of units the standards would allow for good production and then multiply the difference by the standard price of the input.

Variance computations • Spending variance: Find the difference between the actual amount spent on variable overhead and the amount that would have been spent if the predetermined overhead rate had accurately predicted the price of variable overhead per unit of the cost driver. (Actual - Std. Input) • Budget variance: The difference between actual fixed overhead spending and budgeted fixed overhead. (Actual - Master Budget)

Variance computations • The production volume variance measures the difference between budgeted fixed overhead and the amount of fixed overhead that has been included in production costs. (Master Budget - Applied Overhead) • An unfavorable PVV indicates less production than planned: Idle capacity. • A favorable PVV indicates that production (sales) levels are more than adequate to cover the amount of fixed overhead expected to be covered.

Example: The Vanguard Company manufactures one product. Its standard cost system incorporates flexible budgets and assigns indirect costs on the basis of standard DL hrs. At denominator activity, the standard cost per unit is: Direct materials, 3 lbs. @ $5. 00 $15. 00 Direct labor, . 4 hr. @ $20. 00 8. 00 Variable indirect costs, . 4 hr. @ $6. 00 2. 40 Fixed indirect costs, . 4 hr. @ $4. 00 1. 60 Total $27. 00

Example: The Vanguard Company DM DL VOH FOH

Example: The Vanguard Company

Example: The Vanguard Company Direct materials were quoted at $5. 50 per pound throughout September and October to all suppliers. There was no purchase-price variance for materials in October; the price variance shown relates solely to the materials used during October. Wage standards were set in accordance with an annual union contract, but a shortage of workers in the local areas has resulted in rates higher than standard. There were no beginning or ending inventories of work in process.

Example: The Vanguard Company 1. How many units were produced? Use the standard cost column. All the units manufactured cost $243, 000 at standard One unit at standard costs $27. 00 Units produced = $243, 000 / $27. 00 = 9, 000 units

Example: The Vanguard Company 2. What were the actual number of direct labor hours used? Efficiency variance = (actual hrs. /unit - std. hrs. /unit) x actual output x std. price = [actual DL hrs. - (. 4 x 9, 000)] x $20 $4, 000 = actual DL hrs. x $20 - $72, 000 $76, 000 = actual DL hrs. x $20 3, 800 = actual DL hrs.

Example: The Vanguard Company 3. What was the actual wage rate? Labor price variance = (actual rate - std. rate) x actual labor hours $1, 900 = (actual wage rate - $20. 00) x 3, 800 hrs. $1, 900 = actual wage rate x 3, 800 hrs - $76, 000 $77, 900 = actual wage rate x 3, 800 hrs $20. 50 = actual wage rate

Example: The Vanguard Company 4. What was the budget for fixed indirect costs. FOH budget variance = Budgeted FOH - Actual FOH $200 = Budgeted FOH - $15, 800 Actual FOH < Budgeted FOH $16, 000 = Budgeted FOH

Example: The Vanguard Company 5. Denominator activity expressed in direct labor hours. Look at FOH applied: Denominator Volume = 4, 000 DL hrs.

Example: The Vanguard Company 6. How many pounds of direct materials were used? DM quantity variance = (actual quantity used std. quantity for output) x standard price $5, 000 = (actual quantity used - (3 lbs. x 9, 000)) x $5. 00 $5, 000 = actual quantity used x $5. 00 - $135, 000 $140, 000 = actual quantity used x $5. 00 28, 000 lbs. = actual quantity used

Example: The Vanguard Company 7. How many pounds of direct material were purchased? We cannot compute that number from the information given.

Tuesday & Thursday • Midterm exam - 8: 00 a. m. , 152 Comm. West • Thursday: Waltham Motors – Hand in a memo and computations

Group exercise • Use Example Company: Look at the numbers and determine what they all mean. • Compute – Direct material price, quantity and activity variances – Direct labor rate, quantity and activity variances – Overhead variances: spending/budget, efficiency (if applicable), and PVV