PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

Standard Costs and Variances

Chapter 10

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

10-2

Standard CostsStandards are benchmarks or “norms” for

measuring performance. In managerial accounting,two types of standards are commonly used.

Quantity standardsspecify how much of aninput should be used to

make a product orprovide a service.

Price standardsspecify how muchshould be paid foreach unit of the

input.

Examples: Firestone, Sears, McDonald’s, hospitals, construction, and manufacturing companies.

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Standard Costs

DirectMaterial

Deviations from standards deemed significantare brought to the attention of management, apractice known as management by exception.

Type of Product Cost

Am

ou

nt

DirectLabor

ManufacturingOverhead

Standard

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Variance Analysis Cycle

10-5

Setting Standard Costs

Should we useideal standards that require employees towork at 100 percent

peak efficiency?

Engineer Managerial Accountant

I recommend using practical standards that are currently

attainable with reasonable and efficient effort.

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Setting Direct Materials Standards

Standard PriceStandard Priceper Unitper Unit

Summarized in a Bill of Materials.

Final, deliveredcost of materials,net of discounts.

Standard QuantityStandard Quantityper Unitper Unit

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Setting Direct Labor Standards

Use time and motion studies for

each labor operation.

Standard HoursStandard Hoursper Unitper Unit

Often a singlerate is used that reflectsthe mix of wages earned.

Standard RateStandard Rateper Hourper Hour

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Setting Variable Manufacturing Overhead Standards

The rate is the variable portion of the

predetermined overhead rate.

PriceStandard

The quantity is the activity in the

allocation base for predetermined overhead.

QuantityQuantityStandardStandard

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A General Model for Variance Analysis

Variance Analysis

Price Variance

Difference betweenDifference betweenactual price and actual price and standard pricestandard price

Quantity Variance

Difference betweenDifference betweenactual quantity andactual quantity andstandard quantitystandard quantity

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Quantity and Price Standards

Quantity and price standards are Quantity and price standards are determined separately for two reasons:determined separately for two reasons:

The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used.

The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used.

The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production.

The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production.

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Variance Analysis

Materials price varianceMaterials price varianceLabor rate varianceLabor rate varianceVOH rate varianceVOH rate variance

Materials quantity varianceMaterials quantity varianceLabor efficiency varianceLabor efficiency varianceVOH efficiency varianceVOH efficiency variance

A General Model for Variance Analysis

Quantity Variance Price Variance

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A General Model for Variance Analysis

Actual quantity is the amount of direct materials, direct labor, and variable manufacturing overhead actually used.

Quantity Variance(2) – (1)

Price Variance(3) – (2)

(1)Standard Quantity

Allowed for Actual Output,at Standard Price

(SQ × SP)

(2)Actual Quantity

of Input,at Standard Price

(AQ × SP)

(3)Actual Quantity

of Input,at Actual Price

(AQ × AP)

Spending Variance(3) – (1)

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A General Model for Variance Analysis

Standard quantity is the standard quantity allowed for the actual output of the period.

Quantity Variance(2) – (1)

Price Variance(3) – (2)

(1)Standard Quantity

Allowed for Actual Output,at Standard Price

(SQ × SP)

(2)Actual Quantity

of Input,at Standard Price

(AQ × SP)

(3)Actual Quantity

of Input,at Actual Price

(AQ × AP)

Spending Variance(3) – (1)

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A General Model for Variance Analysis

Actual price is the amount actuallypaid for the input used.

Quantity Variance(2) – (1)

Price Variance(3) – (2)

(1)Standard Quantity

Allowed for Actual Output,at Standard Price

(SQ × SP)

(2)Actual Quantity

of Input,at Standard Price

(AQ × SP)

(3)Actual Quantity

of Input,at Actual Price

(AQ × AP)

Spending Variance(3) – (1)

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A General Model for Variance Analysis

Quantity Variance(2) – (1)

Price Variance(3) – (2)

(1)Standard Quantity

Allowed for Actual Output,at Standard Price

(SQ × SP)

(2)Actual Quantity

of Input,at Standard Price

(AQ × SP)

(3)Actual Quantity

of Input,at Actual Price

(AQ × AP)

Spending Variance(3) – (1)

Standard price is the amount that shouldhave been paid for the input used.

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Materials Price VarianceMaterials Quantity Variance

Production Manager Purchasing Manager

The standard price is used to compute the quantity varianceso that the production manager is not held responsible for

the purchasing manager’s performance.

The standard price is used to compute the quantity varianceso that the production manager is not held responsible for

the purchasing manager’s performance.

Responsibility for Materials Variances

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Responsibility for Labor Variances

Production Manager

Production managers areusually held accountable

for labor variancesbecause they can

influence the:

Mix of skill levelsassigned to work tasks.

Level of employee motivation.

Quality of production supervision.

Quality of training provided to employees.

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Advantages of Standard Costs

Management byexception

Advantages

Promotes economy and efficiency

Simplifiedbookkeeping

Enhances responsibility

accounting

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PotentialProblems

Emphasis onnegative may

impact morale.

Emphasizing standardsmay exclude other

important objectives.

Favorablevariances may

be misinterpreted.

Continuous improvement maybe more important

than meeting standards.

Standard costreports may

not be timely.

Invalid assumptionsabout the relationship

between laborcost and output.

Potential Problems with Standard Costs

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FPOHR = Fixed portion of the predetermined overhead rate DH = Denominator hours SH = Standard hours allowed for actual output

SH × FR DH × FR

Fixed Overhead Volume Variance

Volume variance FPOHR × (DH – SH)=

FixedOverheadApplied

ActualFixed

Overhead

BudgetedFixed

Overhead

Volumevariance

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Budget variance

Fixed Overhead Budget Variance

Budgetvariance

Budgetedfixed

overhead

Actualfixed

overhead= –

FixedOverheadApplied

ActualFixed

Overhead

BudgetedFixed

Overhead

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Reconciling Overhead Variances and Underapplied or Overapplied Overhead

In a standardIn a standardcost system:cost system:

Favorablevariances are equivalentto overapplied overhead.

The sum of the overhead variancesequals the under- or overapplied

overhead cost for the period.

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Cost Flows in a Standard Cost System

Inventories are recorded at standard cost.

Variances are recorded as follows: Favorable variances are credits, representing

savings in production costs. Unfavorable variances are debits, representing

excess production costs.

Standard cost variances are usually closed out to cost of goods sold. Unfavorable variances increase cost of goods sold. Favorable variances decrease cost of goods sold.

Inventories are recorded at standard cost.

Variances are recorded as follows: Favorable variances are credits, representing

savings in production costs. Unfavorable variances are debits, representing

excess production costs.

Standard cost variances are usually closed out to cost of goods sold. Unfavorable variances increase cost of goods sold. Favorable variances decrease cost of goods sold.

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End of Chapter 10