CHAPTER 11 Standard Costs and Variance Analysis Standard Costs and Variance Analysis

CHAPTER 11CHAPTER 11CHAPTER 11CHAPTER 11

Standard Costs and Variance Standard Costs and Variance AnalysisAnalysis

Standard Costs and Variance Standard Costs and Variance AnalysisAnalysis

Standard Costs and Standard Costs and BudgetsBudgets

Standard Costs and Standard Costs and BudgetsBudgets

Standard Cost The cost that management believes

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

Often refers to the cost of a single unit

Budgeted Cost The cost, at standard, of the total

number of budgeted units

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Development of Standard Development of Standard CostsCosts


The 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

The 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



Ideal Standards Assumes that no obstacles will be

encountered in the production process

– No breakdowns in equipment– No defects in material

Emphasizes a perfect production environment

Attainable Standards Takes into account possible

circumstances that could lead to costs greater than “ideal”

Study Break #1Study Break #1Study Break #1Study Break #1

What is the primary benefit of a standard costing system?a. It records costs at what should have

been incurredb. It allows a comparison of differences

between actual and standard costsc. It is easy to implementd. It is inexpensive and easy to use

Answer:b. It allows a comparison of differences between actual and standard costs


Which of the following is not a way to develop a standard cost?a. By using a fixed rate that is higher

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

engineering plans

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

A General Approach to A General Approach to Variance AnalysisVariance Analysis

A General Approach to A General Approach to Variance AnalysisVariance Analysis

Standard Cost Variance The difference between a standard and an

actual cost

Variance Analysis Breaking down the differences between

standard and actual cost into two components

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

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

Formula = (AP – SP)AQp

Actual > Standard = Unfavorable

Actual < Standard = Favorable

Material VariancesMaterial VariancesMaterial VariancesMaterial Variances

Material Quantity Variance Difference between the actual

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

Formula = (AQu – SQ)SP



You Get What You Measure!You Get What You Measure!You Get What You Measure!You Get What You Measure!

Example Exercise #1Example Exercise #1Example Exercise #1Example Exercise #1 Crain Computer Company purchased 200

M30 chips for $6.75 each to be used in the production of its CC2140 computer. Standards call for 3 chips for each computer. The standard price for the M30 chip is $60. In July, the company purchased 200 chips for $1,350. The company used 123 chips in the production of 40 computers (3 chips were damaged in the installation process).

Calculate the material price variance and the material quantity variance related to the M640 and indicate if the variances are favorable or unfavorable.

Example Exercise #1 Example Exercise #1 SolutionSolution


Material Price Variance

Actual Price = $1,350/200 = $6.75= (AP - SP) AQP = ($6.75 - $60) 200= ($10,650) favorable



Material Quantity Variance

Standard Quantity = 40 x 3 = 120= (AQU - SQ) SP= (123* - 120) $60= $180 unfavorable

*120 standard quantity + 3 damaged units

Direct Labor VariancesDirect Labor VariancesDirect Labor VariancesDirect Labor Variances

Labor Rate Variance Difference between the actual wage

rate and the standard wage rate multiplied by the actual number of labor hours

Formula = (AR – SR)AH



Direct Labor VariancesDirect Labor VariancesDirect Labor VariancesDirect Labor Variances

Labor Efficiency Variance Difference between the actual number of

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

Formula = (AH – SH)SR



Example Exercise #2Example Exercise #2Example Exercise #2Example Exercise #2

The standard labor cost for the production of a pair of Tukor Brand athletic shoes is .25 hours at $12 per hour. During the month of June, 24,500 pairs of athletic shoes were produced. Actual labor costs were $73,500 for 7,000 hours.

For June, compute the labor rate and labor efficiency variances.



Labor Rate Variances

Actual wage rate = $73,500 ÷ 7,000 hours = $10.50 per hour

= (AR - SR) AH = ($10.50 - $12) 7,000= ($10,500) favorable



Labor Efficiency Variances

Standard hours = 24,500 .25 hours per pair = 6,125 hours

= (AH - SH) SR= (7,000 - 6,125) $12= $10,500 unfavorable

Overhead VariancesOverhead VariancesOverhead VariancesOverhead Variances

Controllable Overhead Variance Difference between actual amount

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

Overhead Volume Variance Difference between flexible budget

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

Example Exercise #3Example Exercise #3Example Exercise #3Example Exercise #3 Barret Hospital is interested in

analyzing overhead related to laundry services. The hospital administrator estimated that monthly fixed costs would be $75,000 and variable costs would be $2.50 per patient day. During the month of September, the hospital had 15,000 patient days. Total laundry costs were $115,000.

Calculate the controllable overhead variance and determine if it is favorable or unfavorable.



Controllable Overhead Variance

= Actual overhead - Flexible budget level of overhead for actual production

= $115,000 - [$75,000 + ($2.50 15,000)]

= $115,000 - $112,500= $2,500 unfavorable

Standard Cost Variance Standard Cost Variance FormulasFormulas

Standard Cost Variance Standard Cost Variance FormulasFormulas

Capacity Variations and the Capacity Variations and the Financial ImpactFinancial Impact

Capacity Variations and the Capacity Variations and the Financial ImpactFinancial Impact

Volume variance only signals that more or fewer units were produced than planned when the standard overhead rate was set Favorable variance when more units

produced than planned Unfavorable variance when fewer units

produced than planned Does not measure financial impact of

operating at more or less than capacity

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

Study Break #3Study Break #3Study Break #3Study Break #3 What does a favorable labor efficiency variance mean?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:d. Less labor was used than called for by standards


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

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

Standard Cost VariancesStandard Cost VariancesStandard Cost VariancesStandard Cost Variances

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

““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

Could indicate poor management decisions

A poor decision regarding the quality of raw materials might result in an unfavorable variance in material quantity

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

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

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

QualityQualityQualityQuality

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CHAPTER 11 Standard Costs and Variance Analysis Standard Costs and Variance Analysis