slide 11-2 chapter 11 standard costs and variance analysis standard costs and variance analysis

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CHAPTER 11CHAPTER 11CHAPTER 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 Standard Costs and BudgetsBudgets


Standard cost- Cost that management believes

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

- Often refers to cost of a single unit

Budgeted cost- Cost, at standard, of the total

number of budgeted units


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

If labor budget is prepared for 1,000 units produced, 3,000 labor hours are needed at total cost of $30,000


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Development of Standard Development of Standard CostsCosts


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


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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


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Ideal standards assumes that no obstacles in production process, i.e.: - no breakdowns in equipment - no defects in materials

Emphasizes a perfect production environment


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Attainable standards takes into account possible circumstances that could lead to costs greater than “ideal”It allows for:

Downtime Inefficiencies Waste


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Ideal standards - Developed under the assumption that no obstacles will be encountered- Ideal standards may not be useful for planning

purposes especially if defects and breakdowns are a fact of life

Attainable standards - Take into account possibility of a variety of

circumstances may lead to costs greater than ideal


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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


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Which of the following is not a way to develop a standard cost?

a. By using a fixed rate that is higher every period

b. By performing time and motion studiesc. By analyzing past datad. By using what is specified in

engineering plans

Answer: aBy using a fixed rate that is higher every period


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A General Approach to A General Approach to Variance AnalysisVariance Analysis


Standard cost variance- Difference between a standard and

an actual cost

Variance analysis- Breaking down the differences

between standard and actual cost into two components, i.e. price and quantity variance


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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


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AQ = Actual quantity SQ = Standard quantity allowed for actual outputAP = Actual price SP = Standard price

StandardCost

SQ X SP

Price variance Quantity variance

Actual CostAQ X AP

Actual Quantityat Standard Price

AQ X SP

Learning objective 2: Calculate and interpret variances for direct material

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Material VariancesMaterial VariancesMaterial VariancesMaterial Variances

Material price variance- Difference between the actual price

per unit of material and the standard price per unit of material

Material quantity variance- Difference between the actual

quantity of material used and the standard quantity of material allowed for the number of units produced

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Material VariancesMaterial VariancesMaterial VariancesMaterial Variances

AQp X SP

AQp = Actual quantity purchasedAQu = Actual quantity usedAP = Actual priceSQ = Standard quantity allowed for actual outputSP = Standard price

Purchased Used

Actual Quantityat Standard Price

AQu X SP

StandardCost

SQ X SP

Price variance Quantity variance

Actual Cost ofMaterial Purchased

AQp X AP



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Material VariancesMaterial VariancesMaterial 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!You Get What You Measure!You Get What You Measure!


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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


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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 3: Calculate and interpret variances for direct labor

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Direct Labor VariancesDirect Labor VariancesDirect Labor VariancesDirect Labor Variances Labor Rate Variance

- Difference between actual wage rate and standard wage rate x actual number of labor hours

Labor Efficiency Variance- Difference between actual number

of hours work and standard labor hours allowed for the number of units produced x standard wage rate

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Direct Labor VariancesDirect Labor VariancesDirect Labor VariancesDirect Labor Variances

AQ = Actual quantity of labor usedAP = Actual labor rate per hourSP = Standard labor rate per hourSQ = Standard quantity of labor allowed for actual output

Standard LaborCost

SQ X SP

Rate variance Efficiency variance

Actual Labor Cost

AQ X AP

Actual Quantity of Labor at Standard Price

AQ X SP


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Direct Labor VariancesDirect Labor VariancesDirect 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


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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


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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 4: Calculate and interpret variances for manufacturing overhead

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Overhead VariancesOverhead VariancesOverhead VariancesOverhead Variances

Controllable overhead variance- Difference between actual amount of

overhead and amount of overhead included in a flexible budget for actual production levels

Overhead volume variance- Difference between flexible overhead

budget for actual level of production and overhead applied using the standard overhead rate

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Overhead VariancesOverhead VariancesOverhead 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 5: Calculate the financial impact of operating at more or less than planned capacity

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Standard Cost Variance Standard Cost Variance FormulasFormulas



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Interpreting Overhead Volume Interpreting Overhead Volume VarianceVariance

Interpreting Overhead Volume Interpreting Overhead Volume VarianceVariance

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

Volume variance signals that more or fewer units were produced than planned when standard overhead rate developed:- Favorable: more units produced than

planned- Unfavorable: fewer units produced than

planned

To measure the financial impact of producing more or fewer units than planned, use incremental analysis


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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


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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


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Investigation of Standard Cost Investigation of Standard Cost VariancesVariances

Investigation of Standard Cost Investigation of Standard Cost VariancesVariances

Standard cost variances do not provide definitive evidence

Should be viewed as an indicator of potential problem areas

Must investigate facts behind the variances


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Standard Cost VariancesStandard Cost VariancesStandard Cost VariancesStandard Cost Variances


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 ExceptionManagement by ExceptionManagement by Exception

Investigation of standard cost variances is a costly activity

Investigate only those variances that are considered exceptional

Must determine criteria to measure what is considered exceptional- Absolute dollar value- 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 Favorable” Variances May Be UnfavorableUnfavorable

““Favorable” Variances May Be Favorable” Variances May Be UnfavorableUnfavorable

A variance that is “favorable” should not be exempt from investigation It could indicate poor management decision

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 Can Process Improvements Lead to “Unfavorable” Lead to “Unfavorable”

Variances?Variances?

Can Process Improvements Can Process Improvements Lead to “Unfavorable” Lead to “Unfavorable”

Variances?Variances? Process improvements can lead to

greater efficiency in production

Greater efficiency results in actual labor hours being less than standard labor hours

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


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Evaluation in Terms of Evaluation in Terms of Variances Can Lead to Excess Variances Can Lead to Excess

ProductionProduction

Evaluation in Terms of Evaluation in Terms of Variances Can Lead to Excess Variances Can Lead to Excess

ProductionProduction 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


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Responsibility Accounting and Responsibility Accounting and VariancesVariances

Responsibility Accounting and Responsibility Accounting and VariancesVariances

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


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QualityQualityQualityQuality


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