Chapter 20 - Production Cost Variance Analyses

CHAPTER 20
PRODUCTION COST VARIANCE ANALYSES
Changes from Twelfth Edition
All changes to Chapter 20 were minor.
Approach
This chapter has a heavy technical content. It is probably desirable to proceed uite slowly with it!
ma"ing sure that each variance is understood. The success#ul student is one who can $reinvent$ the
#ormulas as needed! rather than needing to memori%e them. A good understanding #rom Chapter &' o# the
#low o# costs through the T-accounts in a standard cost system obviously is important in mastering the
techniues o# variance analysis.
Throughout the sessions on this chapter! it is important to stress the uses o# variances. I #eel it particularly
important #or students to reali%e that (&) the overriding goal is to identi#y all o# the elements that caused
actual net income to di##er #rom budget (or another use#ul comparison standard)* (2) the labels
$#avorable$ and $un#avorable$ are algebraic and do not necessarily re#lect whether something $good$ or
$bad$ happened* (+) despite the mathematical #ormulas that isolate variance components! the components
in some instances are interdependent* and (,) the monthly overhead volume variance is not use#ul #or
control purposes.
Cases
SunAir Boat Builders, Inc. as"s students to calculate a #ull set o# production cost variances #or a simple
production company.
Medi-Exam Health Services, Inc. involves both brea"-even analysis and uestions reuiring an
understanding o# overhead variances.
Cotter Company, Inc. is a deceptive case that tests whether the student has really $internali%ed$ the
concepts o# overhead variance analysis.
Lupton Company is a challenging(-) review case on the application o# standard costing and variance
analysis concepts.
Problems
Problem 20-1: Beta Company
a. .aterial variance/
Price variance 0 Price 1 Actual 2uantity
3 Price variance 0 (4&+ - 4&2.,0) 1 +'!000 0 42+!,00 5
6 Price variance 0 (47.80 - 47.90) 1 &&!000 2!200 :
2&!200 5
20-&
Chapter 20 - Production Cost Variance Analyses
:sage variance 0 2uantity 1 ;tandard Price
3 :sage variance 0 (, 1 ,!200 < = 1 +!=00 - +'!000) 1 4&+.00 0 49!700 :
6 :sage variance 0 (& 1 ,!200 < 2 1 +!=00 - &&!000) 1 4 7.80 0 +!,00 5
4,!,00 :
b. >abor variances
?ate variance 0 (4&, - 4&+.=0) 1 2!028 0 47&0 5
@##iciency variance 0 (&A8 1 ,!200 < &A+ 1 +!=00 B 2!028) 1 4&, 0 2&0 5
c. There would be no changes in the answers to & and 2. Prime cost variances are always based on actual
production volume! not planned volume. (;ome students need #reuent reminding o# this #act.)
d. Again! there would be no change* sales volume has no direct impact on production volume! and
hence! not on production cost variances.
Problem 20-2: elta Company
b. Cudgeted overhead at standard volume 0 4&00!000 < 42=.00 (8!000) 0 42+0!000
c. Dverhead absorption rate 0 42+0!000 E 8!000 units 0 4,=.00Aunit
d. .ay absorbed overhead 0 4,=.00Aunit 1 =!000 units 0 429=!000
e. Volume variance 0 Absorbed - Cudgeted
0 429=!000 - F4&00!000 < 42=.00 (=!000)G 0 420!000 5
#. ;pending variance 0 Cudgeted - Actual
0 428=!000 - 4270!000 0 42,!000 :
g. Het variance 0 Absorbed - Actual
0429=!000 - 4270!000 0 4,!000 :
Chec"/ 420!000 5 < 42,!000 : 0 4,!000 :
Problem 20-!: "olb Company
a. (&) Cost system A is the actual variable cost system because 4&0!000 o# #actory indirect costs have
been charged out as an e1pense o# the period in which incurred. Cost o# goods sold is carried
at a lower value than C or C! indicating the inclusion o# only variable costs.
(2) Cost system C is the standard #ull cost system. The presence o# variances indicates this! and
the total costs o# goods sold plus variances euals #ull cost (4'=!000).
(+) Cost system C is the actual #ull cost system (using a predetermined overhead rate) showing the
cost o# goods sold charged with its #air share o# the #actory indirect costs o# the period! and
showing the same total #ull costs o# goods sold as C. (Coth are 4'=!000.)
b.Ac. Dne cannot determine how much o# the overhead was variable because we do not "now how much
o# the 4==!000 actual variable cost represented prime costs (direct material and direct labor). Ie can
say that actual #i1ed #actory overhead was 4+0!000 (4&&0!000 - 470!000 di##erence in other operating
e1penses)! but we cannot determine the amount o# actual variable #actory overhead.
d. 470!000! the operating e1penses are non#actory costs.
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Chapter 20 - Production Cost Variance Analyses
e.
e. ;ince there was an un#avorable overhead variance in system C! not all the #actory indirect costs were
absorbed into the product! meaning #actory volume was not as e1pected. I# two-thirds o# the #i1ed
#actory indirect costs were absorbed into the cost o# goods sold (2A+ 1 4+0!000 0 420!000)! then the
remaining 4&0!000 was not absorbed! indicating volume o# only 2A+! or == 2A+J! o# the normal
#actory volume anticipated when the overhead rate was set. This assumes there was no overhead
spending variance* without this assumption! the answer is indeterminate.
#. Cost system A! the actual variable cost system! is not prepared in accordance with generally accepted
accounting principles! because #ull costs must be used to comply with these principles.
g. Kirect material actual costs were 4,!000 more than planned costs. This is "nown because the
materials variance is un#avorable! indicating actual cost to be greater than planned costs.
h. Problem 20-,/ Koyle Company
a. .olders Trimmers Variance
(&) >abor rate F+!700(4'.00 B '.28)G04'80: F&!=00 (4=.00 B =.&8)G042,0: 4&!&'0:
(2) >abor substitution
(shi#t o# molders to
trimming operation) F200 (=.00 B '.00)G =00:
(+) .aterial substitution
(additional labor due
to discarded cases)
+!&80: 14,.80
&0
9!000
=

&!080: 14&.80
&0
9!000
=

,!200:
(,) Dperating e##iciency
varianceL (28 1 4'.00)0228: (&8 1 4=.00)0'0: +&8:
(8) Idle time (98 1 '.00)0=98: (+8 1 4=.00)02&0: 778:
Total variance............................................................................................................................................................................ 49!&'0:
LKetermination o# operating e##iciency variance.
.olders Trimmers
Actual hours charged to production...................................................................................................................................................... +!700 &!=00
>abor substitution (shi#t o# molders to trimming operation)................................................................................................................. (200) 200
Additional labor hours due to in#erior plastic.......................................................................................................................................
.8

&0
000 ! 9
(+80)
.28

&0
000 ! 9
(&98)
Idle time............................................................................................................................................................................................... (98) (+8)
Actual hours spent producing good cases............................................................................................................................................. +!&98 &!8'0
;tandard hours allowed #or the production o# good cases....................................................................................................................
.8

&0
000 ! =+
+!&80
.28

&0
000 ! =+
&!898
Variance in hours................................................................................................................................................................................. 28: &8:
20-+
Chapter 20 - Production Cost Variance Analyses
b. The supervisor o# the molding department has a valid argument in both cases. The labor substitution
variance was the conseuence o# poor scheduling which is controlled by the production scheduling
department. The supervisor o# the molding department apparently has no responsibility #or or control
over the overall scheduling but has been reuired to compensate #or the production scheduling
departmentMs error. Conseuently! the molding department should not be charged #or the necessary
shi#t o# wor"ers within the department because the supervisor could not control the activities that
caused the shi#t.
The molding department uses the raw materials (plastic) that are acuired by the purchasing department.
The acuisition o# plastic is the responsibility o# the purchasing department and the supervisor o# the
molding department neither controls nor is responsible #or this activity. The purchasing department made
the switch to the in#erior plastic! and they should be held accountable #or this action and resulting
variance.
Cases
Case 20-1: SunAir Boat Builders, Inc
#ote: This case is unchaned !rom the T"el!th Edition# $lease see the printed Instructor%s &esource
'uide !or the Harvard Teachin (otes#
Case 20-2: Medi-Exam Health Services, Inc
!

#ote: This case is unchaned !rom the T"el!th Edition.
Approach
This case provides a review o# brea"-even analysis and pro#itgraphs! while at the same time lin"ing pro#it
budgets and actual results in a way that involves understanding overhead variances. @1hibit & illustrates a
more detailed pro#itgraph #ormat than is described in the te1t* some instructors may wish to ta"e a #ew
minutes to develop the algebraic e1pressions #or the total cost and revenue lines (&2!000 < +23 and 703
respectively) be#ore starting the case discussion. Proceeding in order with the uestions should move
smoothly until 2uestion +! where the conceptual di##erence between a periodMs overhead costs (debits to
the Dverhead clearing account) and overhead e1penses (the amount charged to the periodMs income
statement) will cause di##iculties #or many students. This is one o# several opportunities to rein#orce the
notion that the overhead production volume variance is a #unction o# production volume (tests
per#ormed)! not sales volume (tests billed).
*
This teaching note was prepared by Pro#essor Names ;. ?eece. Copyright O by Names ;. ?eece.
20-,
Chapter 20 - Production Cost Variance Analyses
Answers to $%estions
)uestion *+ Brea,-even
Crea"-even volume 0
.argin on Contributi :nit
Costs 5i1ed
5i1ed costs 0 5i1ed >ab. Dverhead < 5i1ed Admin.
0 420!000 < 4,!000 0 42,!000
:nit contribution margin 0 ;ales revenueA:nit - Variable costA:nit
0 4&=0- (4+2!000L A 800)
0 4&=0-4=,
0 4'=
LVariable costs at 800 e1amsAmonth 0
;upplies............................................................................................................................................................................................................................................ 4 7!000
>abor................................................................................................................................................................................................................................................. =!000
Variable >ab. Dverhead.................................................................................................................................................................................................................... &0!000
Variable Admin................................................................................................................................................................................................................................. 7!000
4+2!000
Crea"-even volume 0
'= 4
000 ! 2, 4
0 280 e1ams
At this point or in 2uestion 2! it is also worthwhile to develop the #ull standard cost o# an e1am! based
on a normal volume o# 800/
@1ams 800
#i1ed 420!000 vbl. 42,!000 +
0 477 A e1am
Hote that the administrative e1penses! which are period rather than product costs! are e1cluded. This
number can be used to veri#y the August standard cost o# services billed/ +&0 e1ams P477 0 429!270.
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Chapter 20 - Production Cost Variance Analyses
)uestion -+ $ro!it per $ro!itraph
Total preta1 pro#it 0 ?evenue - Variable costs - 5i1ed costs
Total preta1 pro#it #or 3 e1ams 0 4&=03 - 4=,3 - 42,!000
Total preta1 pro#it #or +&0 e1ams 0 4&=0(+&0) - 4=,(+&0) - 42,!000
0 4,'!=00 - 4&'!7,0 - 42,!000
0 48!9=0
)uestion .+ Auust /$roduction0 1olume
5i1ed laboratory overhead is absorbed at the rate o# 4,0.00 per physical administered/
,0 4
800
000 ! 20 4
n e1aminatio o# number s monthM Hormal
overhead laboratory 5i1ed
= =
There is a volume variance (debit) o# 4&!=00 #or the period! indicating that overhead has been
underabsorbed (number o# e1aminations given was less than #ormal). 5i1ed laboratory overhead
absorbed by e1aminations given must total 420!000 - 4&!=00 0 4&7!,00. I# 4&7!,00 was absorbed and
the absorption rate is 4,0Aphysical! then ,=0 e1aminations must have been given this period.
Alternatively! i# the approach described in the chapterMs #irst appendi1 is used! the production volume
variance is 4&!=00:! and the absorption rate #or #irst overhead is 4,0Ae1am* so 4&!=00A4,0 0 ,0 #ewer
e1ams than normal (,=0 0 800 - ,0) must have been per#ormed.
)uestion 2+ $ro!it &econciliation
Het pro#it indicated by brea"-even chart #or +&0 e1aminations (2uestion 2) 0 4 8!9=0
Add (items which increased the pro#it shown above)/..........................................................................................................................
5i1ed laboratory overhead assigned to unbilled ;ummations............................................................................................................... =!000L
4&&!9=0
;ubtract (items which dec"ed the pro#it shown above)/.......................................................................................................................
?evenue less than e1pected.................................................................................................................................................................. (,00)<
Dther variances (per income statement)............................................................................................................................................... (&!&20)
Dverspending on administrative e1penses............................................................................................................................................ (2,0)
4&0!000
L,=0 e1aminations were per#ormed but only +&0 were billed. There#ore &80 e1aminations were still unbilled (an
intangible IIP inventory). @ach o# these is allocated 4,0 o# laboratory overhead (4,0 L &80 0 4=!000).
<4&=0 L +&0 e1aminations 0 4,'!=00. Actual revenue was 4,'!200.
@1pected Administrative e1penses were 4,!000 #i1ed < 47!000A800 variable or 4,!000 < 4&= per e1am. 5or +&0
e1aminations! planned costs are 4,!000 < (4&= L +&0) 0 47!'=0. Actual costs were 4'!200.
Case 20-": Cotter Co, Inc
#ote: This case is unchaned !rom the T"el!th Edition. $lease see the printed Instructor%s &esource
'uide !or the Harvard Teachin (otes#
Case 20-#: $u%ton Com%an&
!

#ote: This case is unchaned !rom the T"el!th Edition.
*
This teaching note was prepared by Pro#essor Names ;! ?eece. Copyright O by Names ;. ?eece.
20-=
Chapter 20 - Production Cost Variance Analyses
Approach
This case provides an e1cellent review o# standard costing and variance analysis concepts. ;tudents
cannot plug numbers into #ormulas to uic"ly arrive at most o# the answers* rather! basic concepts and
procedures have to be care#ully thought through. .any students #ind the case #rustrating because it is too
challenging #or them* the instructor should there#ore warn students not to get discouraged i# some
uestions seem beyond them. (The case ma"es an e1cellent e1am! i# the instructor pre#ers di##icult e1ams
to more straight#orward ones.) I suggest devoting two class sessions to this case! trying to get through
uestion && in the #irst session.
Comments on $%estions
&. Ie can de#initely say that material usage and total labor costs were not up to e1pectations (although
without #urther detailed analysis! we do not "now the rate and e##iciency components o# the labor
variance). Ie also "now that actual prices o# materials purchases e1ceeded standard* but this tells us
nothing about the prices o# materials used in production! which is the connotation o# $did we spend
more #or our production operationsQ$ Also! without the detailed analysis called #or in uestions &,-
&9! we cannot say that the un#avorable overhead variances represent overruns o# spending budgets*
conceivably! #avorable spending variances could have been more than o##set by un#avorable
production volume variances.
2. ;ince net overhead variance 0 absorbed - actual! and actual was the same both months! then more
overhead must have been absorbed in .ay than in April. This means that production volume!
however de#ined #or overhead absorption purposes (see uestion ')! was higher in .ay than in April.
Hote that overhead in Cost o# Roods ;old was lower in .ay! but overhead absorbed into Ior" in
Process was higher. ;tudents o#ten #orget the distinction between production volume and sales
volume when answering this sort o# uestion.
+. Iithout re#erence to the supplementary data! we cannot determine whether AprilMs overhead volume
variance was #avorable or un#avorable (uestion &=). ;ome students will incorrectly state that
production volume was above standard! based on the 4&7,!800 direct labor portion o# cost o# goods
sold.
,. 5or the reason given in the answer to uestion 2! we "now that .ayMs production volume was higher
than AprilMs. 5or the reason given in the response to uestion +! we do not "now i# .ayMs production
volume was above or below standard volume. ;ome students will incorrectly in#er that production
volume was 4&2+!000 K>4 because direct labor in cost o# goods sold was 4&2+!000.
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Chapter 20 - Production Cost Variance Analyses
8. ;ales revenues dropped 28 percent while total standard gross margin #ell &&.7 percent. This could
have been caused by two #actors/ (&) an increase in weighted-average per-unit selling price obtained!
or (2) a change in product mi1 that increased the proportion o# sales o# the product having the higher
unit margin. @ither o# these would increase the standard gross margin percentage! which went #rom
27.+ percent in April to ++.+ percent in .ay. (Chapter 2& describes techniues #or isolating these two
#actors.)
=. The easy e1planation is that >upton buys more than one raw material! and other materialsM price
increases more than o##set the decrease on this one particular material. Sowever! the phenomenon
could occur i# >upton had only one raw material/ i# .ayMs purchase price! though lower than AprilMs!
was above the standard! and i# the increase in uantity purchased in .ay versus April more than
o##set the decrease in unit price variance! then the un#avorable price variance would increase. 5or
e1ample/
April &ay
;tandard price per lb............................................................................................................................................................................ 4 8.00 4 8.00
Actual price per lb................................................................................................................................................................................ 4 8.28 4 8.20
Price variance per lb............................................................................................................................................................................. 4 (.28) 4 (.20)
2uantity purchased............................................................................................................................................................................... &!000 lbs. &!+00 lbs.
Total price variance.............................................................................................................................................................................. 4 (280) 4 (2=0)
9. Actual total gross margin in >upton (and many other companies having standard cost systems and
preparing monthly income statements)! is based on standard cost per unit sold and on the monthMs
production variances. Total gross margin at standard is not a##ected by any production activity! nor by
purchasing. The .ay materials price variance was less un#avorable than it would have been had the
price o# this material not dropped* but note that the impact is the same! whether or not the lower-
priced material enters the production process in .ay. The un#avorable material price variance
resulted in an increase in total actual gross margin.
7. The e##ect is e1actly the same as e1plained #or uestion 9. It is caused by the act o# purchasing the
lower-priced materials! not by issuing these materials or selling the goods containing them.
'. Although overhead is absorbed based on production volume! not sales volume! the standard cost
sheets used to determine cost o# goods sold at standard nevertheless will incorporate the absorption
basis. 5or the April and .ay statements! it can be seen that standard overhead is 70 percent o#
standard labor #or both months! whereas it is 98 percent o# standard materials dollars in April and ==
2A+ percent in .ay. There#ore overhead absorption must be based on direct labor dollars! not material
dollars. (Dne would surmise this! o# course! since standard volume is e1pressed in terms o# direct
labor dollars.)
&0. 5rom supplementary note 8! we "now that the sum o# Product AMs standard labor and overhead is
4++.2& (4,8.8& - 4&2.+0). 5rom uestion '! we "now that overhead is absorbed at 70 percent o# direct
labor. Thus! letting 3 0 standard direct labor per unit! we have/
3 < 0.73 0 ++.2&
3 0 &7.,8
&&. The #ollowing calculation can be per#ormed/
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Chapter 20 - Production Cost Variance Analyses
&2.
April &ay
Kebits P std. to IIP............................................................................................................................................................................ +=!'00 &&0!900
.aterials usage variance (dr.).............................................................................................................................................................. &!2+0 +!='0
Variance as percent o# standard............................................................................................................................................................ +.+J +.+J
This shows that the rate at which material was wasted was the same #or both months! even though the
total un#avorable variance was larger in .ay. Thus! whether the uestion is answered in absolute
terms or relative terms! there de#initely was no improvement in materials usage per#ormance.
&+. In >uptonMs system! as goods are moved #rom Ior" in Process to 5inished Roods! the credit to the
#ormer euals the debit to the latter. Thus! the combined accountsM balance is una##ected by this
transaction* so we can #ocus on .ayMs debits to Ior" in Process #or production costs and credits to
5inished Roods #or cost o# goods sold. To determine the debits! we must determine production
volume #or .ay. .ayMs actual production overhead was eual to budgeted overhead at standard
volume (supplementary item ,)! which is 70J L 4&2+!000 0 4'7!,00. ;ince .ayMs net overhead
variance was 4&7!,=0 :! .ayMs absorbed overhead was 49'!',0. Kividing this by the overhead rate
gives .ayMs volume/ 49'!',0 A 0.7 0 ''!'28 K>4. This plus supplementary item & gives us the total
.ay debits to Ior" in Process/ 4+&!+=8 < 49'!++8 < 4''!'28 < 49'!',0 0 42'0!8=8. This is less than
the 4+0!000 credits to 5inished Roods #or cost o# goods sold! so the combined balance in the accounts
decreased.
&,. 5rom uestion &0 and @1hibit & we "now/
'tandard
(nit of
Pdt) A
C*'
April
C*'
&ay
.aterials.............................................................................................................................................................................................. &2.+0 &'=!700 &,9!=00
Kirect labor.......................................................................................................................................................................................... &7.,8 &7,!800 &2+!000
5ull cost................................................................................................................................................................................................ ,8.8& 827!'00 +='!000
.aterials A 5ull cost.............................................................................................................................................................................. 29JL +9J ,0J
K> A 5ull cost....................................................................................................................................................................................... ,&JL +8J ++J
LThese would be the percentages in cost o# goods sold in a hypothetical month in which only Product A was sold.
Either the line o# the ratios o# materials to #ull cost or the line o# the ratios o# direct labor to #ull cost
shows that the proportion o# A sold decreased #rom April to .ay. (I li"e to thin" this is a very subtle
analysis! since the #irst time I taught the case I thought the answer was! $6ou canMt tell.$ The above
analysis was given by a student in that class.) ;ome students will say that the proportion o# A
decreased because supplementary item & shows its production volume decreased* again! this is an
invalid in#erence! since one cannot determine sales volume #rom production volumes without
"nowing changes in inventory.
&8. The #ollowing seuence o# logical steps is needed to answer this uestion (some calculations #rom
above are repeated #or completeness)/
a. The standard volume is 4&2+!000 K>4 (given).
b. The absorption rate is 70J o# K>4 (uestion ').
c. These two #acts imply that budgeted overhead at standard volume 0 70J L 4&2+!000 0 4'7!,00.
Thus! we have one point on the budget line.
20-'
Chapter 20 - Production Cost Variance Analyses
d.
e. The budget #or a volume o# 4&+8!+00 K>4 is 4&02!0'0 (supplementary item 2)* this is our second
point.
#. ;lope 0 rise A run 0 (4&02!0'0 - '7!,00)A(4&+8!+00 - &2+!000)0 4+!='0 A 4&2!+00 0 0.+0. Thus!
budgeted variable overhead is 40.+0 per K>4.
g. ;ince TC 0 :VC L 3! we have
4&02!0'0 0 T5C < 0.+(4&+8!+00)
T5C 0 4&02!0'0 - ,0!8'0
0 4=&!800 budgeted #i1ed
overhead
Chec" '7!,00 0 4=&!800 < 0.+(4&2+!000)
4'7!,00 0 4'7!,00
h. .ayMs actual overhead 0 AprilMs actual overhead 0 4'7!,00 (supplementary items + and , and step
c. above).
i. Het overhead variance 0 absorbed - actual 0 absorbed - 4'7!,00 - &7!,=0 in .ay. Thus .ay
absorbed overhead 0 49'!',0.
T. Cut absorbed overhead 0 0!70 L volume* thus .ay volume 0 49'!',0 A0.7 0 4''!'28 K>4.
". .ayMs overhead budget there#ore is 4=&!800 < 0.+0 (4''!'28) 0 4'&!,99.80.
l. ;ince spending variance 0 budget - actual! .ayMs spending variance 0 4'&!,9 9.80 - '7!,00 0
4=!'22.80 :.
&=. ;ince .ayMs net overhead variance 0 4&7!,=0 :! and the spending variance was 4=!''2.80 :! then the
production volume variance must have been 4&!8+9.80 :. As a chec"! volume variance 0 absorbed -
budget 0 0.7(4''!'28) - F=&!800 < 0.+(''!'28)G 0 49'!',0 - '&!,9980 0 4&&!8+9.80 :.
&9. :sing the same logic as in the answer to uestion &,/
a. Het overhead variance 0 absorbed - actual 0 absorbed - 4'7!,00 0 - 488!+=0. Thus AprilMs
absorbed overhead 0 4,+!0,0.
b. There#ore April volume 0 4,+!0,0 A 0.7 0 48+!700 K>4.
c. Volume variance 0 absorbed - budget 0 4,+!0,0 - F=&!800 < 0.+(8+!700)G 0 4,+!0,0 - 99!=,0 0
4+,!=00 :.
&7. As in uestion &8! since we "now the net variance and one component! the other can be deduced/ -
488!+=0 0 -4+,!=00 < spending variance* there#ore spending variance 0 420!9=0 :.
Dr! as a chec" spending variance 0 budget - actual 0 F4=&!800 < 0.+(8+!700)G - '7!,00 0 499!=,0 -
'7!,00 0 420!9=0 :.
20-&0