Learning Objectives

1
Learning Objectives

• Explain how unit standards are set and why
  standard cost systems are adopted.
• Explain the purpose of a standard cost sheet.
• Describe the basic concepts underlying variance
  analysis and explain when variances should be
  investigated.
• Compute the materials and labour variances and
  explain how they are used for control.

2
Learning Objectives (continued)

• Compute the variable and fixed overhead variances
  and explain their meanings.
• Prepare journal entries for materials and labour
  variances and describe the accounting for
  overhead variances. (Appendix A)
• Use variance analysis as an analytical tool for
  profitability analysis. (Appendix B)

3
Unit Standard Cost

• To determine the unit standard cost for a
  particular input, two decisions must be made
• 1. How much of the input should be used per unit
  of output (Quantity decision)?
• 2. How much should be paid for the quantity of
  the input to be used (Pricing decision)?

4
Types of Standards

• Ideal Standards demand maximum efficiency and can
  be achieved only if everything operates
  perfectly.
• Currently attainable standards can be achieved
  under efficient operating conditions.

5
Sources for Quantitative Standards

• 1. Historical experience
• 2. Engineering studies
• 3. Input from operating personnel

6
Factors for Price Standards - Materials

• 1. Market forces
• 2. Discounts
• 3. Freight
• 4. Quality

7
Factors for Price Standards - Labour

• 1. Market forces
• 2. Trade unions
• 3. Payroll taxes
• 4. Qualifications

8
Purposes of Standards

• To improve planning and control
• To facilitate product costing

9
Cost Assignment Approaches

• 
  Manufacturing Costs
• Direct Direct
• Materials labour Overhead
• Actual costing system Actual Actual Actual
• Normal costing system Actual Actual Budgeted
• Standard costing system Standard Standard Standard
  

10
A Standard Cost Sheet
Standard Standard Standard Description Price Usag
e Cost/Unit Direct materials 1.50/kg. 10
kgs. 15.00 Direct labour
6.00/hr. 2 hours 12.00 Variable overhead
10.00/hr. 2 hours 20.00 Fixed Overhead1
8.00/hr. 2 hours 16.00

63.00 Other Operating Data for
Period Units produced 20,000 units
210,000 kilograms purchased _at_ 1.55 per
kilogram 205,000 kgs. used Direct labour
costs 39,000 hours _at_ 6.10 per hour
Variable overhead 410,000 1Fixed overhead
300,000 Rate (310,000/38,750 hrs)
11
Variable Cost Variance AnalysisGeneral
Description
Actual Quantity of Input at Actual Price AQ x AP
Actual Quantity of Input at Standard Price AQ x SP
Standard Quantity of Input at Standard Price SQ x
SP
Price Variance AQ x (AP - SP)
Usage Variance SP x (AQ - SQ)
Budget Variance (AQ x AP) - (SQ x SP)
12
Variance Investigation

• Variances are investigated if two conditions are
  met
• 1. The variance is material
• 2. The benefits of investigating and taking
  corrective action are greater than its costs

13
Control Limits Standard Allowable Deviation

• Investigating occurs for values outside the
  allowable range.
• Example Assume the allowable deviation may
  be the lesser of 8,000 or 10 of the standard.
  Suppose the standard is 50,000 and the actual
  deviation from standard is 6,000. Will the
  variance be investigated.
• Answer Yes. Ten percent of standard is
  5,000. Since 6,000 is larger than the allowable
  deviation, an investigation will take place.

14
Material Variances
Formula Approach MPV (AP - SP)AQ
MUV (AQ - SQ)SP
(1.55-1.50)210,000
(205,000 - 200,000)1.50 10,500
U
7,500U
SQ 20,000 units x 10 lbs per unit
Diagram Approach
AQ x AP AQ x SP
AQ x SP SQ x SP
210,000 x 1.55 210,000 x 1.50
205,000 x 1.50 200,000 x 1.50
MPV 10,500U
MUV 7,500U
Responsibility
Responsibility
Purchasing
Manufacturing
Flexible Budget Variance 18,000U
15
Labour Variances
Formula Approach LRV (AR - SR)AH
LEV (AH - SH)SR
(6.10 - 6.00)39,000
(39,000 - 40,000)6.00 3,900 U

6,000 F
SQ 20,000 units x 2 hrs. per unit
Diagram Approach
AH x AR AH
x SR SH
x SR
39,000 x 6.10 39,000
x 6.00 40,000 x
6.00
LRV 3,900 U LEV
6,000 F
Responsibility
Responsibility
Human Resources
Manufacturing
Flexible Budget Variance 2,100 F
16
Variable Overhead Variances
Formula Approach OSV (AVOR - SVOR)AH
OEV (AH - SH)SVOR
410,000 - (10 X 39,000 hrs)
(39,000 - 40,000)10.00
20,000 U
10,000 F
SQ 20,000 units x 2 hrs. per unit
Diagram Approach
AH x AVOR AH x
SVOR SH x
SVOR
410,000
39,000 x 10.00
40,000 x 10.00
OSV 20,000 U OEV
10,000 F
Responsibility
Responsibility
Manufacturing
Manufacturing
Flexible Budget Variance 10,000 U
17
Fixed Overhead Variances
Actual Overhead Budgeted Overhead
Applied Overhead
300,000
310,000 SOR x SH (8
x40,000)
OSV 10,000F DV
10,000F
Responsibility
Responsibility Manufacturing
Difficult to Assess
Alternative Approach for Computing FOH
Denominator Variance
Planned level
38,750 hrs. Applied level (SOR)
40,000 hrs. Over
1,250 hrs.
x 8 FOH
Denominator Variance 10,000 F
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APPENDIX AAccounting for Variances
Journal Entry for Purchase of Direct
Materials Materials (AQ x SP) 315,000 MPV (AP -
SP)AQ
10,500 Accounts Payable (AQ x
AP) 325,500 Rule Unfavourable variances are
recorded by a debit and favourable variances are
recorded by a credit.
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Accounting for Variances (continued)
Recording the Issuance of Materials to
Production Work in Process (SQ x
SP) 300,000 MUV (AQ - SQ)SP
7,500 Materials (AQ x
SP) 307,500 AQ Actual quantity used in
production
20
Accounting for Variances (continued)
Recording the Direct Labour Costs Work in
Process (SH x SR) 240,000 LEV (AH - SH) SR
3,900 Accrued
Payroll (AH x AR) 237,900 LRV (AR - SR)
AH 6,000
21
Accounting for Variances (continued)
Recording Variable Overhead Work in Process (SQ
x SP) 400,000 Manufacturing Applied (SQ x
SP) 400,000 Manufacturing Overhead (Actual
Cost) 410,000 Various Accounts 410,000
22
Accounting for Variances (continued)
Recording Fixed Overhead Work in Process (SQ x
SP) 320,000 Manufacturing Overhead
Applied 320,000 Manufacturing Overhead (Actual
Cost) 300,000 Various Accounts 300,000
23
Accounting for Variances (continued)
Recording Overhead Variances and Closing the
Overhead Accounts Manufacturing Overhead Applied
(Variable) 400,000 Manufacturing Overhead Applied
(Fixed) 320,000 OSV (Variable) 20,000 Manufactur
ing Overhead (Variable) 410,000 Manufacturing
Overhead (Fixed) 300,000 OEV (Variable) 10,000
OSV (Fixed) 10,000 DV (Fixed) 10,000
24
Accounting for Variances (continued)
Disposition of Overhead Variances OEV
(Variable) 10,000 OSV (Fixed) 10,000 DV
(Fixed) 10,000 OSV (Variable)
20,000 Cost of Goods Sold 10,000
25
APPENDIX BFurther Analysis of the Profit
Volume Variance

• The profit volume variance can be decomposed
  further, for example into industry volume and
  market share variances
• In the next slide, assume that the master budget
  was based on a certain percentage of market
  share, and that the industry experienced an
  increase in its volume of 10

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Profit Variances from Chapter 13
27
Industry Volume and Market Share Variances
28
Sales Mix Variance

• Assume that the previous statement was for a
  multi-product company, and that its budgeted CMR
  at its budgeted mix was 0.60.
• Assume further that the actual sales mix would
  have resulted in a budgeted CMR of 0.58 instead
• How much is the Sales Mix Variance?
• Answer - 0.02 x 80,000 -1,600 U
• The following spreadsheet includes a
  comprehensive analysis of all profit variances

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Profit Variances - A Comprehensive Analysis
30
Profitability Analysis Problem 14-45

• 1. Total CM per master budget
• A 9,000 x 8 72,000
• B 6,500 x 11 71,500 143,500
• Total standard CM for Actual Quantities
• A 10,000 x 8 80,000
• B 6,000 x 11 66,000 146,000
• Profit Volume Variance (gross) 2,500 F

31
Profitability AnalysisProblem 14-45 (continued)

• 2. Weighted average CM per unit based on master
  budget
• 143,500/15,500 9.2581
• Total standard CM for Actual Quantity 146,000
• Total standard CM for 16,000 units
• assuming budgeted sales mix
• 16,000 x 9.2581 148,129
• Sales mix variance 2,129 U
• Profit volume variance (net)
• (16,000 - 15,500) x 9.2581
  4,629 F

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Profitability Analysis Problem 14-45 (continued)

• 3. Decline in industry sales
• (77,500 - 64,000) x 77,500 17.42
• Industry volume variance
• .1742 x 15,1500 x 9.2581 24,997 U
• Budgeted market share 15,500/77,500 20
• Market share variance
• (16,000-0.20 x 64,000) x 9.2581 29,626 F
• 4. Sales Price Variance
• A 10,000(21 - 20) 10,000 F
• B 6,000(32 - 30) 12,000 F 22,000 F

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Profitability Analysis Problem 14-45 (continued)

• 5. Variable cost flexible budget variances
• Variable manufacturing costs
• A 10,000(12 - 11) 10,000 U
• B 6,000(20 - 18) 12,000 U 22,000 U
• Variable marketing and administrative
• A 10,000(1.10 - 1) 1,000 U
• B 6,000(1.10 - 1) 600 U 1,600
  U
• 23,600 U
• 6. Fixed cost flexible budget variance
• Manufacturing 36,000 - 34,500 1,500 U
• Mktg and admin 44,000 - 40,000 4,000 U
  5,500 U

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Profitability AnalysisProblem 14-45 (continued)

• 7. Budgeted net income 69,000
• Industry volume variance 24,997 U
• Market share variance 29,626 F
• Profit volume variance (net) 4,629 F
• Sales mix variance 2,129 U
• Profit Volume Variance (gross) 2,500 F
• Sales price variance 22,000 F
• Variable cost flex. bud. var. 23,600 U
• Fixed cost flex. bud. var. 5,500 U
• Total profit variances 4,600U
• Actual net income 64,400