managerial accounting, chapter 9 by crosson, needles

Chapter 9

Standard Costingand Variance Analysis

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Standard Costing

Objective 1– Define standard costs, and describe how

managers use these costs.


Standard Costing

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


Standard Costs

• Provide a predetermined performance level for the standard costing method

• Usually stated in terms of cost per unit

Realistic estimates of costs based on analysis of both past and projected

operating costs and conditions


What Are Standard Costs Based On?

• Past costs• Engineering estimates• Forecasted demand• Worker input• Time and motion studies• Type and quality of direct

materials


Standard Costing versus Normal and Actual Costing

Product Cost Elements

Standard Costing

Normal Costing

Actual Costing

Direct Materials Estimated costs Actual costs Actual costs Direct Labor Estimated costs Actual costs Actual costs Overhead Estimated costs Estimated costs Actual costs


Standard Costs and Managers

– Managers use standard costs to develop budgets and establish goals for product costing

• Direct materials

• Direct labor

• Variable overhead

Planning


Standard Costs and Managers (cont’d)

Performing – Managers use standard costs to apply

dollar, time, and quality standards to work

– Actual cost data are collected


Evaluating – Managers compare standard and

actual costs – Compute variances– Variances provide measures of

performance that can be used to control costs and evaluate managers

• Analyze significant variances to reveal operating problems of the cost center or to indicate favorable practices



Communicating – Managers use standard costs to report

on operations in cost centers and on the performance of managers in various cost centers



The Relevance of Standard Costing

in Today's Business Environment• Increased

automation has caused a significant decrease in direct labor costs

• Many companies now apply standard costing only to direct materials and overhead

In manufacturing: In service organizations:

• Use standard costing for labor and overhead costs


Stop & Review

Q. What is the main difference between the standard costing and normal costing methods?

A. The standard costing method uses estimated costs for direct materials and direct labor, whereas the normal costing method uses actual costs for these items. The methods are similar in that both use estimated costs for overhead.


Computing Standard Costs

Objective 2– Explain how standard costs are developed

and compute a standard unit cost.


Computing Standard Costs

– Inventory accounts and the Cost of Goods Sold account are maintained and reported in terms of standard costs

– Standard unit costs used to compute account balances

– Actual costs recorded separately

– Actual and standard costs can then be compared

Fully integrated standard costing system uses standard costs for all elements of product cost

•Direct materials •Direct labor •Overhead


Elements of a Standard Unit Cost

1. Price standard for direct materials

2. Quantity standard for direct materials

3. Standard for direct labor rate

4. Standard for direct labor time

5. Standard for variable overhead rate

6. Standard for fixed overhead rate


Standard Direct Materials Cost

Multiply the price standard for direct materials by the quantity standard for direct materials

Standard Direct Materials Cost

= Direct Materials Price Standard

x Direct Materials

Quantity Standard


Direct Materials Price Standard

• Takes into account– All possible price increases– Changes in available

quantities– New sources of supply

Developed by the purchasing

agent or purchasing department

Is a careful estimate of the cost of a specific direct material in the next accounting period


Direct Materials Quantity Standard

Is an estimate of the amount of direct materials that will be used in the accounting period

(includes scrap and waste)

– The estimate is influenced by: • Product engineering specifications• Quality of direct materials• Age and productivity of machinery• Quality and experience of work force

– Established and monitored by: • Production managers• Management accountants• Others (engineers, purchasing agents, machine operators)


Standard Direct Labor Cost

Calculated by multiplying the standard wage for direct labor by the standard hours of direct labor for a product, task, or job


Direct Labor Rate Standard

• Hourly direct labor rate expected to prevail during the next accounting period– For each function or job classification

• Average standard rate is developed for each task– Standard rate is used even if worker is paid

more or less than the standard rate

• Easy to establish• Rates are set by labor unions or defined by the

company


Direct Labor Time Standard

• Expected time required for each department, machine, or process to complete the production of one unit or one batch of output

• Developed using– Current time and motion studies of workers and

machines

– Records of past performance

• Should be revised when– Machinery is replaced

– Quality of labor force changes


Standard Overhead Cost

Variable Costs Fixed Costs

The sum of the estimates of variable and fixed overhead costs in the next accounting

period

Compute separately because their cost behavior differs


Standard Variable Overhead Rate

Computed by dividing the total budgeted variable overhead costs by an expression of capacity, such as number of standard direct

labor hours or standard machine hours

Total Budgeted Variable Overhead Costs Standard Variable Overhead Rate

= Expected Number of Standard Machine Hours


Standard Fixed Overhead Rate

Computed by dividing the total budgeted fixed overhead costs by an expression of

capacity, usually normal capacity in terms of standard hours or units

Total Budgeted Fixed Overhead Costs Standard Fixed Overhead Rate

= Normal Capacity in Terms of Standard Machine Hours

Normal capacity is the level of operating capacity needed to meet expected sales demand

Its use ensures that all fixed OH* costs have been applied to units produced by

the time normal capacity is reached

*Overhead


Total Standard Unit Cost Illustrated

Remember When, Inc., recently updated the standards for its line of watches

Direct materials price standards Casing materials $9.20 per square foot Movement mechanism $2.17 each Direct materials quantity standards Casing materials .025 square foot per watch Movement mechanism 1 per watch Direct labor time standards Case Stamping Department .01 hour per watch Watch Assembly Department .05 hour per watch Direct labor rate standards Case Stamping Department $8.00 per hour Watch Assembly Department $10.20 per hour Standard manufacturing overhead rates Standard variable overhead rate $12.00 per direct labor hour Standard fixed overhead rate $9.00 per direct labor hour

Compute the total standard cost of one watch


Stop & Review

Q. Why are the variable and fixed components for the standard overhead cost computed separately?

A. Variable costs and fixed costs are computed separately because their cost behavior differs.


Variance Analysis

Objective 3– Prepare a flexible budget, and describe

how managers use variance analysis to control costs.


Variance Analysis

The process of computing the differences between standard costs and actual costs and identifying the causes of those differences

Accuracy of variance analysis depends on the kind of budget used•Static Budget •Flexible Budget


Static Budgets

• Also called fixed budgets

• Do not allow for changes in output level

• If actual output differs from budgeted output, a variance between actual and budgeted amounts will occur

• Cannot judge performance accurately

Forecast revenues and expenses for just one level of sales and one level of output


Performance Report Using Data from a Static Budget


Flexible Budgets

Summary of expected costs for a range of activity levels

• Also called variable budgets• Provide forecasted data that can be

adjusted for changes in output level• Used primarily as a cost control tool in

evaluating performance


Flexible Budget Formula

An equation that determines the expected, or budgeted, cost for any level of output• Includes:

– Per unit amount for variable costs

– Total amount for fixed costs

Costs Fixed Budgeted Produced) Unitsof No. per Unit Cost (Variable Costs Budgeted Total


Flexible Budget for Evaluation of Overall Performance


Flexible Budget Formula Illustrated

Remember When, Inc.:

$9,450 Produced) Unitsof No. ($3.71 Costs Budgeted Total

$9,450 19,100) ($3.71 Costs Budgeted Total $9,450 $70,861

$80,311

The company produced 19,100 units:


Performance Report Using Data from a Flexible Budget


Is the variance significant?

Using Variance Analysis to Control Costs

Compute variance

No corrective action needed

No

Yes

Analyze variance todetermine its cause

Select performance measures to correct

the problem

Take corrective action

Step 1

Step 2

Step 3

Step 4


Using Variance Analysis to Control Costs (cont’d)

– But, this does not prevent the variance from happening again

– Must determine the cause:• Select performance measures that will help track the

problem

• Must then find the best solution

Computing variances are important


Stop & Review

Q. What is the flexible budget formula?

per Unit Cost (Variable Costs Budgeted Total

Produced) Unitsof No.

Costs Fixed Budgeted

A. It is an equation used to determine expected, or budgeted costs for any level of output.


Computing and Analyzing Direct Materials Variances

Objective 4– Compute and analyze direct materials

variances.


Why Compute and Analyze Variances?

• To control whole cost categories – Such as total direct materials costs

• To control elements of those categories– Such as the price and quantity of each direct

material

The more detailed the analysis of a variance is, the more effective managers

will be in controlling costs


Computing Direct Materials Variances

Total direct materials cost variance is the difference between the standard cost and actual

cost of direct materials


Direct Materials Variances Illustrated

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.

cost Standard

bag)per feet 4 bags (180foot per $6.00$4,320 720foot per $6.00

cost actual Less

4,484 760foot per $5.90

quantity standard price Standard

quantity actual price Actual

ncecost varia materialsdirect Total (U) 164 $

Actual cost > standard cost

This is an unfavorable (U) situation


Direct Materials Variances

• 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


Computing Direct Materials Variances

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

Price) Actual Price (Standard Variance Price MaterialsDirect Quantity Actual

feet 760 $5.90) ($6.00

Because the company paid less for direct materials than it expected, the variance is favorable (F)

(F) $76


Computing Direct Materials Variances (cont’d)

Direct materials quantity variance– Difference between the standard quantity allowed and

the actual quantity used multiplied by the standard price

– Also called the direct materials efficiency or usage variance

Quantity (Standard Price Standard VarianceQuantity MaterialsDirect Quantity) Actual Allowed

feet) 760 feet (720 $6.00

Because the company used more for direct materials than it expected, the variance is unfavorable (U)

(U) $240


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

Direct materials price variance $ 76 (F) Direct materials quantity variance 240 (U) Total direct materials cost variance $164 (U)


Diagram of Direct Materials Variance Analysis


Analyzing and Correcting Direct Materials Variances

Company had experienced direct materials price and quantity variances for some time

Managers tracked purchasing activities•Discovered that the purchasing agent had purchased, without authorization, a lower grade of leather at a reduced price •After analysis, engineers determined the lower grade leather was not appropriate

Discovered that inferior leather was causing the unfavorable quantity variance


Stop & Review

Q. What is the direct materials price variance?

Price) Actual Price (Standard Variance Price MaterialsDirect Quantity Actual

A. It is the difference between the standard price and the actual price per unit multiplied by the actual quantity purchased. It is also called the direct materials spending or rate variance.


Computing and Analyzing Direct Labor Variances

Objective 5– Compute and analyze direct labor variances.


Computing Direct Labor Variances

Total direct labor cost variance is the 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


Direct Labor Variances IllustratedAt 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.

cost Standard

bag)per hours 2.4 bags (180 $8.50

$3,672 hours 432 $8.50 cost actual Less

4,140 hours 450 $9.20

allowed hours standard rate Standard

hours actual rate Actual

ncecost varialabor direct Total (U) 468 $



Direct Labor Variances

Total direct labor cost variance must be broken into 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

Hours Actual x Rate) Actual Rate (Standard Variance RateLabor Direct

hours 450 $9.20) ($8.50

(U) $315

Because the company paid more per hour for direct labor than it expected, the variance is

unfavorable


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

hours) 450 hours (432 $8.50

(U) $153 Because the company used more direct labor hours than it

expected, the variance is unfavorable (U)

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



• If correct, the net of the direct labor rate variance and direct labor efficiency variance will equal the total direct labor cost variance

Direct labor rate variance $ 315 (U) Direct labor efficiency variance 153 (U) Total direct labor cost variance $468 (U)


Diagram of Direct Labor Variance Analysis


Analyzing and Correcting Direct Labor Variances

Materials handling– Parts delivered late on five occasions

• Will track delivery time and number of delays for next three months

Employee time cardsAn assembly worker who had fallen ill was replaced with a machinery operator from another department

Assembly worker is paid $8.50 per hour and the machine operator is paid $9.20 per hourMachine operator not as skilled as the assembly worker

Temporary situation so no corrective action taken


Stop & Review

Q. What is the direct labor efficiency variance?

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

A. The direct labor efficiency variance is the 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. It is also called the direct labor quantity or usage variance.


Computing and Analyzing Overhead VariancesObjective 6

– Compute and analyze overhead variances.


Computing and Analyzing Overhead Variances

– Responsibility for 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

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

materials and direct labor costs


Using a Flexible Budget to Analyze Overhead Variances

– For overhead costs only– Evaluate activity level using direct labor hours

• Variable costs vary with the number of direct labor hours worked

• Total fixed overhead costs remain constant

• Cambria Company’s managers use a flexible budget to evaluate performance


Flexible Budget for

Evaluation of Overhead

Costs


Using a Flexible Budget to Analyze Overhead Variances

• Flexible budget formula when applied to Cambria’s data:

Hour Labor Direct per Costs (Variable Costs OH Budgeted Total

Hours)Labor Direct ofNumber

Costs OH Fixed Budgeted

Hours)Labor Direct of No. ($5.75 Costs OH Budgeted Total

$1,300

To find the total monthly budgeted overhead costs, insert direct labor hours into the flexible budget

• Flexible budget formula:


Computing Overhead Variances

– Standard overhead costs are applied to production using a standard overhead rate

• Standard overhead rate has two parts– Variable rate

– Fixed rate

Difference between actual overhead costs and standard overhead costs applied


Computing Overhead Variances (cont’d)

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

rate overhead Fixed

$3.25 hourslabor direct 400 $1,300

rate overhead standard Total

$9.00 $3.25 $5.75

capacity normal overhead fixed Budgeted

rate overhead fixed standard rate overhead variableStandard


888,3$ bag)per hours 2.4 bags (180hour labor direct per $9.00 costs overhead actual Less

varianceoverhead Total (U) 212 $

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

4,100

produced units good toapplied costs OH Standard

This amount can be divided into variable overhead variances and fixed overhead variances


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

Computing Overhead Variances (cont’d)


Variable Overhead Variances

The total variable overhead variance is the difference between actual variable overhead costs and the standard

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


Variable Overhead Variances (cont’d)

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


bag)per hours 2.4 bags (180hour per $5.75

cost actual Less

produced units good toapplied Overhead

ncecost varia overhead variableTotal (U) 16 $

allowed hourslabor direct standard rate variableStandard

2,500$2,484 hours 432 $5.75


Diagram of Variable Overhead Variance Analysis


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 Variances (cont’d)


Variable Overhead Spending VarianceDifference between the budgeted variable overhead costs

at actual hours and actual variable overhead; also called the variable overhead rate variance

Actual Rate Variable (Standard OH Variable Actual Worked)Hours

$2,500 hours) 450 ($5.75 (F) $87.50

Hours Actualat Costs Variable Budgeted Variance Spending OH Variable Overhead Variable Actual


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

(Standard Rate Variable Standard Variance Efficiency OH Variable

Hours) Actual Allowed Hours


Compute variable overhead efficiency variance

Variable Overhead Variances

hours) 450 hours (432 $5.75

Bagper Hours Standard Produced UnitsGood Allowed Hours Standard bagper hours 2.4 bags 180

hours 432

(U) 50.103$

(Standard Rate Variable Standard Variance Efficiency OH Variable

Hours) Actual Allowed Hours

Compute standard hours allowed



• If correct, the net of the variable overhead spending variance and variable overhead efficiency variance will equal the total variable overhead cost variance

Variable overhead spending variance $ 87.50 (F) Variable overhead efficiency variance 103.50 (U) Total variable overhead cost variance $ 16.00 (U)


Fixed Overhead Variances

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


Diagram of Fixed

Overhead Variance Analysis


Fixed OverheadVariances Illustrated

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.

bag)per hours 2.4 bags (180hour per $3.25

produced units good toapplied Overhead

ncecost varia overhead fixed Total (U) 196 $

allowed hourslabor direct standard rate fixed Standard

cost actual Less 1,600$1,404 hours 432 $3.25


Analyze Two Parts

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

Overhead Fixed Budgeted VarianceBudget OH Fixed

Overhead Fixed Actual

$1,600 $1,300

(U) $300


Fixed Overhead Volume Variance

Difference between budgeted fixed overhead costs and overhead costs applied to production

using the standard fixed overhead rate

produced units good toapplied OH fixed Standard

bag)per hours 2.4 bags (180 hour labor direct per $3.25 $1,404overhead fixed budgeted totalLess 1,300

variance volumeoverhead Fixed (F) 104 $


Fixed Overhead Variances

– Fixed overhead volume variance measures the use of existing facilities and capacity

– Favorable overhead volume variance• Capacity exceeds the expected amount

– Unfavorable overhead volume variance• Company operates at a level below normal capacity

– May be in best interest of company during periods of slow sales

– Means company is not building up excess inventory

• A volume variance will occur if more or less than normal capacity is used


Summary of Overhead Variances

Variable overhead spending variance $ 87.50 (F) Variable overhead efficiency variance 103.50 (U) Fixed overhead budget variance 300.00 (U) Fixed overhead volume variance 104.00 (F) Total overhead variance $212.00 (U)


Analyzing and Correcting Overhead Variances

Variance Amount Cause Corrective Action Variable overhead spending variance

$87.50 (F) Savings on purchases No action

Variable overhead efficiency variance

103.50 (U) Inefficiency of machine operator who substituted for ill assembly worker

Consider feasibility of implementing a program for cross-training employees

Fixed overhead budget variance

300.00 (U)

Higher than expected factory insurance premiums due to increased claims filed by employees

Study insurance claims filed over a three-month period

Fixed overhead volume variance

104.00 (F) Overutilization of capacity traced to high seasonal demand

No action necessary because variance fell within anticipated range


Stop & Review

Q. What four variances are used to analyze the total overhead variance?

A. Variable overhead spending variance Variable overhead efficiency variance

Fixed overhead budget variance

Fixed overhead volume variance


Using Cost Variances to Evaluate Managers’ Performance

Objective 7– Explain how variances are used to evaluate

managers’ performance.


Factors in Fairness of Performance Evaluation

• Human factors

• Company policies– Should be based on input from managers

and employees– Should specify procedures that managers

are to use


Procedures to Specify for Managers

• Preparing operational plans• Assigning responsibility for carrying out the

operational plans• Communicating operational plans to key

personnel• Evaluating performance in each area of

responsibility• Identifying causes of significant variances from

the operational plan• Taking corrective action to eliminate problems


Variance Analysis

• Provides detailed data about differences between standard and actual costs– Effective at pinpointing efficient and

inefficient operating areas• Basic comparison of budgeted and actual data

not as effective


Using Cost Variances to Evaluate Managers’ Performance (cont’d)

– Identify causes of the differences, personnel involved, corrective actions taken

– Be tailored to the manager’s specific areas of responsibility

Managers should only be held accountable for cost areas under their control

• Effective managerial performance reports based on standard costs and related variances should


Managerial Performance Reports

• Summarize all cost data

• Include variances for direct materials, direct labor, and overhead

• Identify– Causes of variances– Corrective actions taken


Stop & Review

Q. What items should be included in an effective managerial performance report?

A. Summarization of all cost dataVariances for direct materials, direct labor, and overhead

Identification of the causes of the variances, personnel involved, and any corrective actions taken


Chapter Review

1. Define standard costs, and describe how managers use these costs.

2. Explain how standard costs are developed, and compute a standard unit cost.

3. Prepare a flexible budget, and describe how managers use variance analysis to control costs.


Chapter Review (cont’d)

4. Compute and analyze direct materials variances.

5. Compute and analyze direct labor variances.

6. Compute and analyze overhead variances.

7. Explain how variances are used to evaluate managers’ performance.

managerial accounting, chapter 9 by crosson, needles

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standard unit cost1

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