MANAGERIAL ACCOUNTING · Web viewVARIANCE ANALYSIS One of the major management used of standard costs is to identify variances from standards. Variances are difference between total

Managerial Accounting Chapter - 5

MANAGERIAL ACCOUNTING

STANDARD COSTING AND VARIANCE ANALYSISa. Standard costs and standard costingb. Comparison of standard costs and budgetsc. Introduction to standard cost variances d. Direct materials variances e. Direct labor variancesf. Variable production overhead variances g. Fixed production overhead variances h. Sales prices and sales volume variances

Introduction

Standard, the expected levels of performance Standards play an important role in our daily life. When attending school or college, a student must perform at a certain level on a standard achievement exam in order to graduate and earn a diploma or a degree. When dining in a restaurant, a patron expects a certain level of quality in the food served and when purchasing a product a consumer demands a certain level of dependability and service.

A standard can be defined as a benchmark or norm for measuring performance. Standards are also common in business. Here the standards relate to the Quantity and cost of inputs used in manufacturing

goods.

Quantity and Cost Standards are set by managers for the three elements of cost input – materials, labor

and overhead.

Quantity Standards say how much of a cost element such as raw materials or labor time should be used

in manufacturing a unit.

Cost Standards say what the cost of labor time or the materials should be.

Actual quantities and actual costs of inputs are measured against these standards to see whether the

operations are within the limits that management has set.

This chapter is focusing the tools used by managerial accountants to assist managers in controlling an organization’s operations and costs. Any control system has three basic parts.

1. A predetermined or standard performance level2. A measure of actual performance and3. The comparison between standard and actual performance.

A managerial accountant’s budgetary control system works like a thermostat.

Standard costs and standard costing

A standard cost is a budget for the production of one unit of product or service

Standard costing is a method of cost control that includes a measure of actual performance and a measure of the difference, or variance, between standard and actual performance

Faculty: Dr. Uvesh Husain Mazoon University College1


A managerial accountant’s budgetary-control system has three parts. First, a predetermined or standard cost is set. In essence, a standard cost is a budget for the production of one unit of product or service. It serves as the benchmark in the budgetary-control system. When the firm produces more than one unit, the managerial accountant uses the standard unit cost to determine the budgeted cost of production or the total standard cost. Second, the managerial accountant measures the actual cost incurred in the production process. Third, the managerial accountant compares the actual cost with the budgeted or standard cost. Any difference between the two is called a cost variance. Cost variances then are used in controlling costs.

Managers do not have time to investigate every variance between actual and standard costs. They focus their attention on the causes of significant cost variances. This is called management by exception. When operations are going along as planned, actual costs and profit will typically be close to the budgeted amounts. However, if there are significant departures from planned operations, such effects will show up as significant cost variances. Managers investigate these variances to determine their causes, if possible, and take corrective action when indicated.

Two methods are typically used for setting cost standards: analysis of historical data and task analysis. One indicator of future costs is historical cost data. In a mature production process, where the firm has a lot of production experience, historical costs can provide a good basis for predicting future costs. In using task analysis, the emphasis shifts from what the product did cost in the past to what it should cost in the future. The managerial accountant typically works with engineers to conduct studies in an effort to determine exactly how much direct material should be required, how machinery should be used in the production process, and many direct labor hours are required.

Standards should not be determined by the managerial accountant alone. People generally will be more committed to meeting standards if they are allowed to participate in setting them. For example, production supervisors should have a role in setting production cost standards, and sales managers should be involved in setting targets for sales prices and volume. In addition, knowledgeable staff personnel should participate in the standard-setting process.

Standards that are as tight as practical, but still are expected to be attained, are called practical (or attainable) standards. Such standards assume a production process that is as efficient as practical under normal operating conditions. Practical standards allow for such occurrences as occasional machine breakdowns and normal amounts of raw-material waste.

Some managers believe that perfection standards motivate employees to achieve the lowest cost possible. They claim that since the standard is theoretically attainable, employees will have an incentive to come as close as possible to achieving it. Other managers and many behavioral scientists disagree. They feel that perfection standards discourage employees, since they are so unlikely to be attained. Moreover, setting unrealistically difficult standards may encourage employees to sacrifice product quality to achieve lower costs.

There are two types of standard cost variances: price variance and quantity variance. A price variance arises when there is a difference between the actual price and the standard price. A quantity variance occurs when there is a difference between the actual quantity used and the standard quantity to be used.



STANDARD VS BUDGET:Essentially standards and Budgets are the same thing. The only difference between the two terms is

that a standard is a unit amount where as Budget is a total amount. If the standard cost for material per

unit is $5, and 1000 units are budgeted to be produced during a period then the budgeted cost of

material is 5000$. A standard may be viewed as the budgeted cost for one unit of product.

Advantages of Standard Costing

When standard costs are set carefully and used wisely, they yield several benefits to an organization.

1. They help managers plan by providing the unit amount – a building blocks for budgeting

2. They help managers control business operations by setting target levels of operating

performance.

3. They help motivate employees by serving a benchmarks against which their performance is

measured.

4. They provide unit costs that are useful in setting the sale price of products or services.

5. They help simplify record keeping, reducing clerical costs.



Effectiveness and EfficiencyOften terms such as effectiveness and efficiency are used to rate favorable performance, while in

effective and in efficient are used to rate un favorable performance.

Effectiveness relates to whether an objective is achieved.

Efficiency either hand is a measure of the means by which an objective is achieved. This

whether it is achieved with the least amount of effort and the least possible cost.

For example, if a sales representative is required to make a trip from New York to Florida to attend a

sales convention, she may choose a target flight from New York to Florida, which would be both efficient

and effective. Alternatively, she could take a flight from New York to California and then take another

flight from California to Florida. Although this rate would effective - both objective is to attend a sales

convention in Florida - the means by which it is achieved is in efficiency. Evaluating a ineffectiveness

and efficiency of an Employee’s performance requires the setting of expected levels of performance or

standards.VARIANCE ANALYSIS

One of the major management used of standard costs is to identify variances from standards.

Variances are difference between total actual costs and total standard costs.Variance analysis

• used to evaluate performance• separate measures of effectiveness and efficiency

DIRECT MATERIAL VARIANCES

Computing and Analyzing Direct Materials Variances• To control operations, managers compute and analyze variances for

– Whole cost categories• Such as total direct materials costs

– Elements of those categories• Such as the price and quantity of each direct material

Computing Direct Materials Variances• Total direct materials cost variance

– Difference between the standard cost and actual cost of direct materials

Cambria Company makes leather bags. Each bag should use 4 feet of leather (standard quantity), and the standard price of leather is $6.00 per foot. During August, the company purchased 760 feet of leather costing $5.90 per foot and used the leather to produce 180 bags

Faculty: Dr. Uvesh Husain Mazoon University College

ncecost varia materialsdirect Total (U) 164 $

4


• Total direct materials cost variance must be broken into two parts to find the cause of the variance– Direct materials price variance– Direct materials quantity variance

• Direct materials price variance– Difference between the standard price and the actual price per unit multiplied by the actual

quantity purchased– Also called the direct materials spending or rate variance

• Direct materials quantity variance

– Difference between the standard quantity and the actual quantity used multiplied by the

standard price

– Also called the direct materials efficiency or usage variance

• Test calculations of variances– If correct, the net of the direct materials price variance and direct materials quantity

variance will equal the total direct materials cost variance


Price) Actual Price (Standard Variance Price MaterialsDirect Quantity Actual

Quantity (Standard Price Standard VarianceQuantity MaterialsDirect Quantity) Actual Allowed

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DIRECT LABOR VARIANCES• Total direct labor cost variance

– Difference between the standard direct labor cost for good units produced and actual direct labor costs• Good units are the total units produced less units

that are scrapped or need to be reworked

Computing Direct Labor Variances At Cambria Company, each leather bag requires 2.4 standard direct labor hours, and the standard direct labor rate is $8.50 per hour. During August, 450 direct labor hours were used to make 180 bags at an average pay rate of $9.20 per hour



• Total direct labor cost variance must be broken onto two parts to find the cause of the variance

– Direct labor rate variance – Direct labor efficiency variance

• Direct labor rate variance – Difference between the standard direct labor rate and

the actual direct labor rate multiplied by the actual direct labor hours worked

– Also called the direct labor spending variance

• Direct labor efficiency variance – Difference between the standard direct labor hours

allowed for good units produced and the actual direct labor hours worked multiplied by the standard direct labor rate

– Also called the direct labor quantity or usage variance

• Test calculations of variances – If correct, the net of the direct labor rate variance and

direct labor efficiency variance will equal the total direct labor cost variance


ncecost varialabor direct Total (U) 468 $

Rate) Actual Rate (Standard Variance RateLabor Direct Hours Actual

Allowed Hours (Standard Rate Standard Variance EfficiencyLabor Direct Hours) Actual

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Diagram of Direct Labor Variance AnalysisVariances:

Computing and Analyzing Manufacturing Overhead Variances

• Controlling variable and fixed overhead costs is more difficult for managers than controlling direct materials and direct labor costs

– Responsibility for manufacturing overhead costs is hard to assign

• Fixed overhead costs– Unavoidable past costs– Not under the control of any department manager

• Variable overhead costs– Some control possible if they can be related to

departments or activities

• Total manufacturing overhead variance– Difference between actual overhead costs and standard

overhead costs• Standard overhead costs are applied to production using

a standard overhead rateFaculty: Dr. Uvesh Husain Mazoon University College8


– Standard overhead rate has two parts» Variable» Fixed

For Cambria Company, the standard variable overhead rate is $5.75 per direct labor hour (from the flexible budget). Total budgeted overhead is $1,300 by normal capacity, which is 400 direct labor hours.

For Cambria Company, the standard variable overhead rate is $5.75 per direct labor hour (from the flexible budget). Budgeted Fixed overhead is $1,300 by normal capacity, which is 400 direct labor hours & Actual Overhead costs $ 4100. Total standard overhead rate is= 1300/400= 3.25 + 5.75 = $ 9.00.

• Variable Overhead Variance

• Total variable overhead variance


produced units good No.( rate OH standard Total allowed) hours standard

varianceoverhead ingmanufactur Total (U) 212 $

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– Difference between actual variable overhead costs and the standard variable overhead costs that are applied to good units produced using the standard variable rate

At Cambria Company, each leather bag requires 2.4 standard labor hours and the variable overhead rate is $5.75 per direct labor hour. During August, the company incurred $2,500 of variable overhead costs


ncecost varia overhead variableTotal (U) 16 $

10


• Total variable overhead cost variance must be broken into two parts to find the cause of the variance

– Variable overhead spending variance– Variable overhead efficiency variance

• Variable overhead spending variance– Difference between the budgeted variable overhead costs at

actual hours and actual variable overhead

• Variable overhead efficiency variance– Difference between the standard direct labor hours allowed

for good units produced and the actual hours worked multiplied by the standard variable overhead rate

• Compute standard hours allowed

• Compute variable overhead efficiency variance


Overhead Variable Actual

OH Variable Actual Worked)Hours

(Standard Rate Variable Standard Variance Efficiency OH Variable Hours) Actual Allowed Hours

(Standard Rate Variable Standard Variance Efficiency OH Variable Hours) Actual Allowed Hours

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• Test calculations of variances– If correct, the net of the variable overhead spending variance

and variable overhead efficiency variance will equal the total variable overhead cost variance

• Total fixed overhead variance– Difference between actual fixed overhead costs and the

standard fixed overhead costs that are applied to good units produced using the standard fixed overhead rate

–



At Cambria Company, each leather bag requires 2.4 standard direct labor hours and the standard fixed overhead rate is $3.25 per direct labor hour. During August, the company incurred $1,600 of actual fixed overhead costs & Budgeted Fixed Overhead cost - $ 1300

Formula : Standard fixed Overhead costs – Actual Fixed overhead costs

• Total fixed overhead cost variance must be broken into two parts to find the cause of the variance

– Fixed overhead budget variance– Fixed overhead volume variance

• Fixed overhead budget variance– Difference between the budgeted and actual fixed overhead

costs– Also called budgeted fixed overhead variance


cost actual Less 1,600

ncecost varia overhead fixed Total (U) 196 $

Overhead Fixed Budgeted VarianceBudget OH Fixed Overhead Fixed Actual

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• Fixed overhead volume variance– Difference between budgeted fixed overhead costs and

manufacturing overhead costs applied to production using the standard fixed overhead rate

Formula : Standard Fixed Overhead Costs – Budget Fixed Overhead costs

Summary of Manufacturing Overhead Variances

Important points Manufacturing Overhead variances

1. Variable Overhead Efficiency Variance (difference between actual usage and allowed usage multiplied by a standard rate per cost driver unit)

2. Variable Overhead Spending Variance (difference between actual cost and the expected cost of variable overhead)

3. Production Volume Variance (difference between applied fixed overhead and budgeted fixed overhead)

4. Fixed Overhead Spending Variance (difference between actual fixed overhead and budgeted fixed overhead)

Sales volume variance(Flexible budget units - Static budgeted units) x budgeted contribution margin per unit


ncecost varia overhead variableTotal (F) 104 $

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= (10,000 - 12,000) x $81 = $162,000 U

Sales price variance= (actual selling price - budgeted selling price) x actual units sold= ($185 - $180) x 10,000 units = $50,000 F

Problems NO:1Frankfort company uses a standard costing system. The following information is available for the

November production.

Standard price per unit of direct materials $3.00 per gallon

Actual price per unit of direct material $2.80 per gallon

Standard quantity of direct materials per unit of production 5 gallons

Actual quantity of direct materials used in production 5,200 gallons

Actual quantity of direct materials purchased 4,000 gallons

Actual production 1,000 units.

Required: Calculate

(i)Direct material price variance assuming that when materials are purchased and when materials are

used.

ii) Direct material quantity variance.

Problem No: 2During the month of august micro companies direct material cost for the manufacture of product X where

as follows:

Actual price per unit of direct material $6.50 per lb.

Standard quantity of direct materials allowed for production 2100 lb

Actual quantity of direct materials used in production 2300 lbs.

Standard price per unit of direct materials $6.25 per lb.

On the basis of this information compute direct material quantity variance and direct material price

variance for the month of august.

Problem No: 3The following information is available for the Jackson company.

Standard rate per direct labor hour $5 per hour

Actual rate per direct labor hour $5.50 per hour

Standard direct labor hours per unit 2 hours



Actual direct labor hours used 600 hours

Actual production 350 units.

On the basis of this above information compute direct labor rate variance and direct labor efficiency

variance.

Problem No: 4The following information is available for ABC companies production activities for the month of October

2006.

Units produced 1000 units

Actual direct labor hours used 2100 hours

Standard direct labor hours per unit of production 2 hours

Actual rate per direct labor hour $10

Standard rate per direct labor $12

On the basis of this information compute direct labor rate variance and direct labor efficiency variance.

Problem No: 5Manlow company makes a cologne called Allure. The Standard Cost for One bottle of Allure is as

follows:

Manufacturing cost elements Standard

Quantity Price Cost

Direct Material 6 oz $ 0.90 $ 5.40

Direct Labor 0.5 hrs 12.00 6.00

Manufacturing Overhead 0.5 hrs 4.80 2.40

$13.80

During the month, the following transactions occurred in manufacturing 10,000 bottles of Allure.

1. 58,000 ounces of material were purchased at $ 1.00 per ounce2. All the materials purchased were used to produce bottles of Allure3. 4,900 D.L.H were worked at a total labor cost of $ 56,3504. Variable Manufacturing Overhead incurred was $ 15,000 and Fixed Overhead incurred was $

10,400.Manufacturing Overhead rate of $ 4.80 is based on normal capacity of 5200 Direct labor hours. The total budget at this capacity is $ 10,400 fixed and 14,560 variable.

Required.

Total Direct Material Cost Variance, Direct Material Price Variance, Direct Material Quantity Variance, Total Direct Labor Cost Variance, Direct Labor Rate Variance, Direct Labor Efficiency Variance and Total Manufacturing Overhead Cost Variance.



Problem No: 6Jasper has the following budget and actual figures for May:

Budget ActualSales Units 600 620Sales Price per Unit $ 30 $ 29Standard full cost of production is $ 28 per unit.Required: Calculate the SP variance and the sales volume variance.


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MANAGERIAL ACCOUNTING · Web viewVARIANCE ANALYSIS One of the major management used of standard costs is to identify variances from standards. Variances are difference between total