Chapter 11 PP

8/8/2019 Chapter 11 PP

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Chapter Eleven

STANDARD COSTS AND

VARIANCE ANALYSIS


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Objectives

1. Explain how standard costs are developed.

2. Calculate and interpret variances for directmaterials.

3. Calculate and interpret variances for directlabor.

4. Calculate and interpret variances formanufacturing overhead.

5. Calculate the impact on costs of operatingat more or less than planned capacity.


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Objectives (Continued)

6. Discuss how the management by

exception approach is applied toinvestigation of standard cost variances.

7. Explain why even favorable variancesmay need to be investigated and why

care must be take in interpretingvariances.


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Standard Costs

1. Standard cost refers to expected costs

under anticipated conditions.2. Standard cost systems allow forcomparison of standard versus actualcosts.

3. Differences are referred to as standardcost variances.4. Variances should be investigated if

significant.


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Standard Costs and Budgets

1. Standard cost is the standard cost of a

single unit.2. Budgeted cost is the cost, at standard,of the total number of budgetedunits.


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Development ofStandard

Costs

1. Standard costs are developed in a

variety of ways:a. Specified by formulas or recipes.

b. Developed from price lists providedby suppliers.

c. Determined by time and motionstudies conducted by industrialengineers.

d. Developed from analyses of pastdata.


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Ideal Versus Attainable

Standards

Ideal standards (perfection standards):

assume that no obstacles to theproduction process will be encountered.

Attainable Standards: developed under

the assumption that there will beoccasional problems in the productionprocess.


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A General Approach To

Variance Analysis

1. Direct material: materials price and

materials quantity variance.2. Direct labor: labor rate (price) and laborefficiency (quantity) variance.

3. Overhead: overhead volume variance

and controllable overhead variance.


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Material Variances

1. Differences between standard andactual material costs:

a. Material price variance.

b. Material quantity variance.


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Material Price VarianceCOMPARES THE ACTUAL PRICE (AP) PAID FORMATERIALS TO THE STANDARD PRICE (SP) FORTHE QUANTITY OF MATERIALS PURCHASED (AQp) .

Material price variance = (AP SP) x AQp

UNFAVORABLE (U) if the actual price > standard price:

FAVORABLE (F) if the actual price < standard price:

*THIS ALSO MAY BE COMPUTED AS ACTUAL COSTOF PURCHASES MINUS SP X AQp.


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Material Quantity VarianceCOMPARES THE ACTUAL QUANTITY OF MATERIALS USED(AQu) FOR MATERIALS TO THE STANDARD QUANTITY

ALLOWED* (SQ) FOR THE QUANTITY OF MATERIALS

EVALUATED AT THE STANDARD PRICE. (SP)

Material quantity variance = (AQu SQ) x SP

UNFAVORABLE (U) if the actual quantity > standard price.

FAVORABLE (F) if the actual quantity < standard price.

*THE STANDARD QUANTITY ALLOWED IS THE STANDARDQUANTITY PER UNIT TIMES THE NUMBER OF UNITSPRODUCED.


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Direct Labor Variances

1. Differences between standard and actualdirect labor costs due to:

a. Labor rate (price) variance.

b. Labor efficiency (quantity) variance.


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Labor Rate Variance

COMPARES THE ACTUAL WAGE RATE (AR) PAID FORLABOR TO THE STANDARD RATE (SR) FOR THEQUANTITY OF LABOR USED (AH).

Labor rate variance* = (AR SR) x AH

UNFAVORABLE (U) if the actual rate > standard rate:FAVORABLE (F) if the actual rate < standard rate:

*THIS ALSO MAY BE COMPUTED AS ACTUAL DIRECTLABOR COSTS MINUS SR X SH.


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Labor Efficiency Variance

COMPARES THE ACTUAL LABOR HOURS USED (AH) TOTHE STANDARD QUANTITY OF HOURS ALLOWED (SH)*EVALUATED AT THE STANDARD WAGE RATE. (SR)

Labor efficiency variance = (AH SH) x SR

UNFAVORABLE (U) if the actual hours > standard hours.

FAVORABLE (F) if the actual hours < standard hours.

*THE STANDARD QUANTITY OF HOURS ALLOWED ISTHE STANDARD HOURS PER UNIT TIMES THE NUMBEROF UNITS PRODUCED.


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Overhead Variances

1. Differences between actual overhead costsand overhead applied to inventory atstandard overhead costs are due to:

a. Controllable overhead variances.

b. Overhead volume variance.


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Controllable Overhead

Variances1. Compare actual overhead costs to flexible

budget overhead costs for the actual volume ofproduction.

2. Referred to as controllable because managersare expected to control costs.

UNFAVORABLE (U) if the actual cost > flexible budget.FAVORABLE (F) if the actual cost < flexible budget.

sum of controllable overhead variances for individualcosts is the total controllable variance.


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CONTROLLABLE OVERHEAD

VARIANCES

The controllable overhead variances can be

analyzed into price and efficiencycomponents. Example: the electric utility bill may have an

unfavorable variance because we used toomany KW hours, or because of a rate hike.

The sum of controllable overhead variancesfor individual costs is the total controllableoverhead variance.


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Overhead Volume Variance

1. Overhead volume variance compares the flexiblebudget level of overhead for actual level ofproduction output to applied overhead using thestandard overhead rate.

2. This variance is solely the result of a different

number of units being produced than planned inthe static budget.

3. Unfavorable indicates underutilized capacity

4. Favorable indicates overutilized capacity.


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Measuring The Financial Impact Of

Operating At More or Less Than

Planned Capacity

1. Operating at less than planned capacityresults in an unfavorable variance equal tothe number of units (less than planned) xthe standard fixed cost per unit.

2. Operating at more than planned capacity

results in a favorable variance equal to thenumber of units (more than planned) x thestandard fixed cost per unit.


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Comprehensive Example:

Darrington Ice Cream

Standard Costs Per Unit:

Item Qty. x Price = TotalDirect Materials: .8 gal. 2.50 = $2.00

Direct Labor: .125 hrs. 12.00= $1.50

Mfg. Overhead: $ .75

Total Cost Per Unit (Standard) $4.00


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Comprehensive Example:

Darrington Ice Cream


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Material Variances

1. Material price variance:(AP SP) x AQp :($2.72 - $2.50) x 810,000 = $178,200unfavorable.

2. Material quantity variance: (AQu SQ)SP:(809,000 800,000) x $2.50 = $22,500

unfavorable.


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Labor Variances

1. Labor rate (price) variance: (AR SR)AH:($12.10 - $12.00) x 130,000 = $13,000unfavorable.

2. Labor efficiency (quantity) variance:(AH SH)SR: (130,000 125,000) x $12 =

$60,000 unfavorable.


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Overhead Variances

1. Controllable overhead variance: Actualoverhead ($) - flexible budget level ofoverhead ($) for the actual volume ofproduction: $680,000 - $700,000 = $20,000favorable.

2. Overhead volume variance: flexible budgetlevel of overhead for actual level ofproduction - overhead applied to productionusing standard overhead rate: $700,000 -

$750,000 = $50,000 favorable.


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Investigation ofStandard Cost

Variances

1. Standard cost variances are not a definitivesign of good or bad performance.

2. Large Variances are merely indicators ofpotential problems which should beinvestigated.

3. There are many plausible explanations for

them.


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Management By Exception1. Investigation of standard cost variances is a

costly activity

2. Management must decide which variances toinvestigate.

3. Most managers practice management byexception.

4. What is exceptional? Usually an absolute dollaramount or a percentage amount. For examplethe policy may be to investigate variances thatare more than 10% above or below standard.


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Favorable Variances May Be

Unfavorable

1. A favorable variance does not mean thatit should not be investigated.

2. For example a favorable raw materialsprice variance may indicate inferior qualitymaterials

3. As a result there may be substantially morescrap and rework, which would show up asunfavorable quantity and efficiencyvariances.


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Responsibility Accounting and

Variances

1. Managers should be held responsible onlyfor costs they can control.

2. This is also true in the area of varianceanalysis.

3. Sometimes areas of responsibility overlap.4. A purchasing agent will be held responsible

for direct material price variances, but whatabout material quantity (usage) variances?


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Appendix: Recording Standard

Costs

1. Accounting information systems can bedesigned to routinely measure cost

variances for materials, labor andoverhead.

2. Inventory accounts are kept at standardcost, making inventory accounting easier

3. Variance accounts are closed periodicallyeither to cost of goods sold or to incomesummary.


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Recording Material CostsPurchase of raw materials inventory (perpetual system):Account dr. cr.Raw Material Inventory (std.) xxx

Material Price Variance* x Accounts Payable (actual) xxxx

Usage of raw materials inventory:

Account dr. cr.Work in Process Inventory xxxMaterial Quantity Variance* x

Raw Material Inventory xxxx* Unfavorable variances


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Recording Labor CostsRecording Labor Cost:

Account dr. cr.

Work in Process Inventory (std.) xxxLabor Rate Variance* x

Labor Efficiency Variance* x

Wages/Sal. Payable (actual) xxxxx

*unfavorable variances


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Recording Manufacturing

Overhead: Step 1

To record actual overhead cost:

Account dr. cr.

Manufacturing Overhead Control xxxxx

*Various Accounts xxxxx

*indirect labor, utilities, supplies, insurance,depreciation, supervisory costs etc.


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Overhead: Step 2

To apply overhead cost to work in process

inventory at standard cost:

Account dr. cr.

Work in Process Inventory xxx

Manufacturing Overhead xxx


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Overhead: Step 3

To identify variances and close

manufacturing overhead control account

Account dr. cr.Overhead Volume Variance* x

Controllable Overhead Variance(s)* xManufacturing Overhead xx

* Unfavorable (they would be a credit if favorable)


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Recording Finished Goods and Cost of

Goods Sold

To record completed units sent to finished goods:

Account dr. cr.

Finished Goods Inventory xxxxx

Work in Process Inventory xxxxx

To record cost of goods sold

Account dr. cr.Cost of Goods Sold xxxxx

Finished Goods Inventory xxxxx


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Closing Variance AccountsTemporary variance accounts must be closed at the end ofthe period.Account dr. cr.

Cost of Goods Sold xxxxxxOverhead Volume Variance xControllable Overhead Variance xMaterial Price Variance xMaterial Quantity Variance x

Labor Rate Variance xLabor Efficiency Variance x

*This example assumes all variances were unfavorable


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Quick Review Question #1

1. What does an unfavorable overheadvolume variance mean?

a. Overhead costs are out of control.

b. Overhead costs are under control.

c. Production was greater than

anticipated.d. Production was less than

anticipated.


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1. What does an unfavorable overheadvolume variance mean?

a. Overhead costs are out of control.

b. Overhead costs are under control.

c. Production was greater than

anticipated.d. Production was less than

anticipated.


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2. Standard material costs per unit are$3.50. Actual costs per unit are $3.80

Actual quantity is 3,000. Standardquantity is 2,800. Material pricevariance is:

a. $900 favorable

b. $900 unfavorablec. $700 favorable

d. $700 unfavorable


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Actual quantity is 3,000. Standardquantity is 2,800. Material pricevariance is:

a. $900 favorable


d. $700 unfavorable


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Actual quantity is 3,000. Standardquantity is 2,800. Material quantityvariance is:

a. $900 favorable


d. $700 unfavorable


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4. What does a favorable labor efficiencyvariance mean?

a. Labor rates were higher than calledfor by standards.

b. Inexperienced labor was used,causing the rate to be lower than

standard.c. More labor was used than called

for by standards.

d. Less labor was used than called for

by standards.


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4. What does a favorable labor efficiencyvariance mean?

a. Labor rates were higher than calledfor by standards.

b. Inexperienced labor was used,causing the rate to be lower than

standard.c. More labor was used than called

for by standards.

d. Less labor was used than called for

by standards

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Chapter 11 PP