Prepared by Debby Bloom-Hill CMA, CFM

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CHAPTER 11CHAPTER 11

Standard Costs

and

Variance Analysis

Standard Costs

and

Variance Analysis

Learning objective 1: Explain how standard costs are developed

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Standard Costs and Budgets

Standard Costs and Budgets

Standard cost Cost that management believes

should be incurred to produce a product or service under anticipated conditions

Standard costs can be used by manufacturing and service companies A tool manufacturer may set a standard cost for producing a hammer

A bank may set a standard cost for processing a check

Learning objective 1: Explain how standard costs are developed

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Standard Costs and Budgets

Standard Costs and Budgets

The term standard cost often refers to the cost of a single unit

The term budgeted cost often refers to the cost, at standard, of the total number of budgeted units The cost information contained in

budgets must be consistent with standard costs

Learning objective 1: Explain how standard costs are developed

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Standard Costs and Budgets

Standard Costs and Budgets

If materials budget indicates purchases of 5,000 pounds, standard cost is $25,000 (5,000 pounds * $5 standard cost per pound)

If labor budget is prepared for 1,000 units produced, 3,000 labor hours are needed at a standard cost of $30,000 (3,000 hours * $10)

Learning objective 1: Explain how standard costs are developed

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StarbucksStarbucks

Learning objective 1: Explain how standard costs are developed

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Development of Standard Costs

Development of Standard Costs

Standard costs for material, labor and overhead are developed in a variety of ways Standard quantity and price for

material may be specified: In engineering plans that provide a list of material

In recipes or formulas By time and motion studies In price lists provided by suppliers

Learning objective 1: Explain how standard costs are developed

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Development of Standard Costs

Development of Standard Costs

Standard quantity and rate for direct labor may be specified: By time and motion studies Through analysis of past data By management expectations of rates

to be paid In contracts that set labor rates

Standard costs for overhead involves procedures similar to those used to develop predetermined overhead rates

Learning objective 1: Explain how standard costs are developed

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Ideal versus Attainable Standards

Ideal versus Attainable Standards

In developing standard costs, some managers emphasize ideal standards while others use attainable standards Ideal standards assumes that no

obstacles to the production process will be encountered Managers who support ideal standards believe they motivate employees to strive for the best possible control over production costs

Learning objective 1: Explain how standard costs are developed

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Ideal versus Attainable Standards

Ideal versus Attainable Standards

Attainable standards are standard costs that take into account the possibility that a variety of circumstances may lead to costs that are greater than ideal If equipment breakdowns and

defects are a fact of life, it makes sense to plan for their associated costs

Most managers support the use of attainable standards

Learning objective 1: Explain how standard costs are developed

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What is the primary benefit of a standard costing system?

a. It records costs at what should have been incurred

b. It allows a comparison of differences between actual and standard costs

c. It is easy to implementd. It is inexpensive and easy to use

Answer: bIt allows a comparison of differences between actual and standard costs

Learning objective 1: Explain how standard costs are developed

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Standard CostingStandard Costing

Learning objective 1: Explain how standard costs are developed

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A General Approach to Variance Analysis

A General Approach to Variance Analysis

Companies that use standard costing can analyze the difference between a standard and an actual cost Called a standard cost variance

Determines whether operations are being performed efficiently

The analysis is called variance analysis It generally involves breaking down the differences between standard and actual cost into two components

Learning objective 1: Explain how standard costs are developed

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A General Approach to Variance Analysis

A General Approach to Variance Analysis

Direct material variances Material price variance Material quantity variance

Direct labor variances Labor rate variance Labor efficiency variance

Manufacturing overhead variances Overhead volume variance Controllable overhead variance

Learning objective 2: Calculate and interpret variances for direct material

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Material VariancesMaterial Variances

Material price variance Difference between the actual price

per unit of material (AP) and the standard price per unit of material (SP) times the actual quantity of material purchased (AQ)

Material quantity variance Difference between the actual quantity

of material used (AQ) and the standard quantity of material allowed for the number of units produced (SQ) times the standard price of material (SP)

Learning objective 2: Calculate and interpret variances for direct material

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Material VariancesMaterial Variances Standard for 1 unit: 400 lbs @ $10 per lb Materials purchased: 200,000 lbs @ $9.90

per lb Materials used: 181,000 lbs to produce 450

units

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You Get What You Measure!You Get What You Measure!

Learning objective 2: Calculate and interpret variances for direct material

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Data for chips used in the production of computersStandard: 3 chips per computer @ $6.50 per chipQuantity purchased: 200 chips for total of $1,350 Quantity used: 123 chips for production of 40 units

Calculate the material price variance

$1,350 - $1,300 = $50Unfavorable price variance

200 X $6.75$1,350

200 X $6.50$1,300

Actual Cost ofMaterial Purchased

AQp X AP

Actual Quantity of Material Purchased at Standard Price

AQp X SP

Learning objective 2: Calculate and interpret variances for direct material

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Data for chips used in the production of computersStandard: 3 chips per computer @ $6.50 per

chipQuantity purchased: 200 chips for $1,350 totalQuantity used: 123 chips for production of 40

units

Calculate the material quantity variance:

$800 - $780 = $20Unfavorable quantity variance

Actual Quantity of Material Used at Standard Price

AQu X SPStandard Cost

SQ X SP123 X $6.50

$800(40 X 3) X $6.50

$780

Learning objective 2: Calculate and interpret variances for direct material

Learning objective 3: Calculate and interpret variances for direct labor

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Direct Labor VariancesDirect Labor Variances Labor Rate Variance

Difference between actual wage rate (AR) and standard wage rate (SR) times the actual number of labor hours worked (AH)

Labor Efficiency Variance Difference between actual number

of hours worked (AH) and the standard labor hours allowed for the number of units produced (SH) times the standard labor wage rate (SR)

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Direct Labor VariancesDirect Labor Variances Standard for 1 unit: 4 hours @ $15 per hour Actual labor: 1,700 hours @ $15.50 per hour

to produce 450 units

Learning objective 3: Calculate and interpret variances for direct labor

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Data for labor used in the production of sneakersStandard: .25 hours per sneaker at $12.00 per hourActual quantity produced: 24,500 sneakersQuantity used: 6,000 hours, total cost $69,000

Calculate the labor rate variance:

$69,000 - $72,000 = ($3,000)Favorable rate variance

Actual LaborAH X AR

Actual Quantity of Labor at Standard Rate

AH X SR6,000 X $11.50

$69,0006,000 X $12.00

$72,000

Learning objective 3: Calculate and interpret variances for direct labor

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Data for labor used in the production of sneakersStandard: .25 hours per sneaker at $12.00 per hourActual quantity produced: 24,500 sneakersQuantity used: 6,000 hours, total cost $69,000

Calculate the labor efficiency variance:

$72,000 - $73,500 = ($1,500)Favorable efficiency variance

6,000 X 12$72,000

(24,500 X .25) X $12.00$73,500

Actual Quantity of Labor at Standard Rate

AH X SRStandard Labor Cost

SH X SP

Learning objective 3: Calculate and interpret variances for direct labor

Learning objective 4: Calculate and interpret variances for manufacturing overhead

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Overhead VariancesOverhead Variances

Controllable overhead variance Difference between the actual amount

of overhead and amount of overhead that would be included in a flexible budget for the actual level of production

Overhead volume variance Difference between the amount of

overhead included in the flexible budget and the amount of overhead applied to production using the standard overhead rate

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Overhead VariancesOverhead Variances Standard for 1 unit: $50 overhead applied Actual overhead: $23,000 to produce 450

units Flexible budget overhead: $15,000 fixed +

$20 per unit produced

Learning objective 3: Calculate and interpret variances for direct labor

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Interpreting Overhead Volume Variance

Interpreting Overhead Volume Variance

Volume variances do not signal that overhead costs are in or out of control

A volume variance signals that the quantity of production was greater or less than anticipated

The usefulness of the volume variance is limited It signals only that more or fewer

units have been produced than planned when the standard overhead rate was set

Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity

Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity

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Standard Cost Variance Formulas

Standard Cost Variance Formulas

Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity

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Standard Cost Variance Formulas

Standard Cost Variance Formulas

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A favorable labor efficiency variance means:a. Labor rates were higher than called for by

standardsb. Inexperienced labor was used, causing the

rate to be lower than standardc. More labor was used than called for by

standardsd. Less labor was used than called for by

standards

Answer: dLess labor was used than called for by standards

Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity

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What does an unfavorable overhead volume variance mean?

a. Overhead costs are out of controlb. Overhead costs are in controlc. Production was greater than anticipatedd. Production was less than anticipated

Answer: d Production was less than anticipated

Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity

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Investigation of Standard Cost Variances

Investigation of Standard Cost Variances

Standard cost variances do not provide definitive evidence that costs are out of control and managers are not performing effectively They should be viewed as an

indicator of potential problem areas The only way to determine whether

costs are being effectively controlled is to investigate the facts behind the variancesLearning objective 5: Calculate the financial impact of

operating at more or less than planned capacity

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Standard Cost VariancesStandard Cost Variances

Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity

Learning objective 6: Discuss how the management-by-exception approach is applied to the investigation of standard cost variances

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Management by ExceptionManagement by Exception

Investigation of standard cost variances is a costly activity A management by exception

approach is to investigate only those variances that are considered exceptional

Must determine criteria to measure what is considered exceptional Absolute dollar value of the

variance The variance as a percent of actual

or standard cost

Learning objective 7: Explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms of variances may lead to overproduction

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“Favorable” Variances May Be Unfavorable

“Favorable” Variances May Be Unfavorable

The fact that a variance is favorable does not mean that is should not be investigated A favorable variance may be

indicative of poor management decisions

A poor decision regarding the quality of raw materials might result in an unfavorable variance in material quantity

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Can Process Improvements Lead to “Unfavorable”

Variances?

Can Process Improvements Lead to “Unfavorable”

Variances? A firm may have an unfavorable

variance because it engaged in process improvements They can lead to greater efficiency

which results in actual labor hours being less than standard labor hours

Firms should stimulate greater demand to take advantage of the greater production capabilities

Learning objective 7: Explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms of variances may lead to overproduction

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Evaluation in Terms of Variances Can Lead to Excess

Production

Evaluation in Terms of Variances Can Lead to Excess

Production When bottlenecks exist, the

department in front of the bottleneck should not produce more than the bottlenecked department can handle

If it does it will create excess work-in-process inventory and result in a negative impact on shareholder value

Learning objective 7: Explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms of variances may lead to overproduction

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Responsibility Accounting and Variances

Responsibility Accounting and Variances

The central idea of responsibility accounting is that managers should be held responsible for only the costs they can control

Additionally, managers and workers should only be held responsible for variances they can control

Learning objective 7: Explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms of variances may lead to overproduction

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QualityQuality

Learning objective 7: Explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms of variances may lead to overproduction

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