Variances and Standard Costs

1
Variances and Standard Costs

• Chapter 23

2
Standards

• A standard is a measure of performance
• Students often measure themselves relative to the
  average in the class or a self determined goal.
• The average in a class is a standard.
• So is a self determined goal
• Accountants also use standards

3
Standard Costs

• Standard costs systems use a set of standards to
  measure financial results.
• Standard costing systems are common in both
  process costing and job order costing
  environments.
• Standards should attainable
• not too easy to attain that they are meaningless
• not so difficult so that they are only
  theoretical.

4
Budgetary Performance

• Standards are used to evaluate flexible budget
  performance.
• Standards are usually a standard cost per item x
  standard quantity per item
• For example Model XR has two components A B

5
Budgetary Performance

• Item A has a standard cost of 3 and a quantity
  of 2.
• So item A standard cost for model XR would have a
  cost of 3 x 2 6.
• Item B has a standard cost of 5 and a quantity
  of 4.
• So Item B standard cost for model XR would have a
  cost of 5 x 4 20.

6
Budgetary Performance

• So the standard material cost for model XR would
  be
• Item A 6
• Item B 20
• Total 26

7
Variances

• Assume actual cost was determined to be 20 per
  unit.
• The variance would be 20 - 26 (6).
• By convention, the variance is calculated as
  actual cost standard or flexible budget cost.
• The negative 6 variance is called a favourable
  variance.

8
Variance

• If the actual cost was 30.
• The variance would be 30 - 26 4.
• The 4 positive variance is called an
  unfavourable variance.
• A favourable variance, regardless of sign, is
  favourable as it is below standard.
• An unfavourable variance, regardless of sign is
  unfavourable as it is above standard.

9
Raw Materials Variance

• The raw materials variance we saw before is
  actually composed of two variances
• Direct raw materials price variance
• Direct raw materials quantity variance
• Recall that the total cost of raw materials is
  composed of two components
• Units of raw material used
• Cost of the raw material used

10
Raw Materials Variance

• For analysis purposes it is necessary to examine
  both
• The materials used in comparison to standard
• The price of materials used in comparison to
  standard

11
Direct Raw Materials Price Variance

• Assume that items A is used in a production
  process
• Standard cost for item A is 5 and standard
  quantity is 100 units for a standard cost of 500
• Actual costs price and quantity were 4.90 X 120
  units 588
• 588 - 500 88 Unfavourable variance

12
Direct Raw Material Price Variance

• In the Direct Raw Material Price Variance we
  isolate only on the price of Raw Materials
• In our case actual price standard price 4.90
  - 5.00 (0.10) x actual quantity 120 (12)
  Favourable variance
• This computation ignores standard quantities

13
Direct Raw Materials Quantity Variance

• In the Direct Raw Material Quantity Variance we
  isolate on quantities used
• Actual quantity Standard quantity 120 100
  20 units Unfavourable variance.
• 20 units x standard price 20 x 5.00 100
  unfavourable variance

14
Direct Materials Variance Relationships
Actual Cost Actual quantity x Actual price
Standard Cost Standard quantity x Standard Price
Actual quantity x Standard price
12 F Materials Price Variance
100 U Materials Quantity Variance
88 U Total Direct Materials Cost Variance
15
Analysis of Variances

• The analysis of our variances indicates that the
  price per unit was lower than standard but the
  quantity used was higher than standard
• Possible that an inferior quality product was
  used report this to the purchasing department
• Inferior product was a lower cost per unit
• Improvement in cost was more than outweighed by
  the increase in quantity used

16
Direct Labour Variances

• We can use the same basic technique on labour
  costs as well.
• Assume that quality stucco uses the standard rate
  of 20.00 per hour
• Standard hours are 24 hours per job
• Actual results are 35 hours at 10.00 per hour
  350

17
Direct Labour Variances

• Standard costs are 20 x 24 480.
• Actual Standard costs 350- 480 (130)
  Favourable variance

18
Direct Labour Rate Variance

• Similar conceptually to the direct raw materials
  price variance.
• Actual labour rate Standard labour rate x
  actual hours
• 10- 20 (10) F x 35 (350) Favourable
  variance

19
Direct labour Time (Efficiency) Variance

• The direct labour time or efficiency variance is
  similar conceptually to the direct materials
  quantity variance
• Actual hours Standard hours X Standard Rate
• 35 hours 24 hours 11 hour Unfavourable
  variance x 20 220 Unfavourable variance.

20
Direct Labour Variance Relationships
Actual Cost Actual hours x Actual price
Standard Cost Standard hours x Standard Price
Actual hours x Standard price
350F Labour Rate Variance
220 U Labour Time (Efficiency) Variance
130 F Total Direct Labour Cost Variance
21
Analysis of Variances

• Analysis indicates that there was a substantial
  favourable variance in the labour rate variance.
• There was also a substantial Unfavourable
  variance in the efficiency or labour time rate.
• The favourable variance in labour rate outweighed
  the unfavourable efficiency variance.
• These variances may be due to a scheduling
  problem which should be reported to supervisors.

22
Factory Overhead Variances

• Factory Overhead Variances are more difficult to
  analyze as the relationship between costs
  incurred and production volume is less direct
• The Flexible budget for factory overhead is
  computed by dividing the budgeted factory
  overhead by the expected volume of the activity
  driver

23
Factory Overhead Variances

• If the budgeted factory overhead is 10,000 and
  direct labour hours is 2,000
• The factory overhead rate is 10,000 / 2,000
  5.00 per direct labour hour.
• Actual variable factory overhead rate is 11,000
  with actual direct labour hours of 1,900 hours

24
Factory Overhead Variances

• Factory Overhead Variances can result from two
  situations
• Actual variable cost is less than or greater than
  the budgeted amount.
• Actual amount of production is above or below
  normal capacity.

25
Variable Factory Overhead Controllable Variance

• Variable Factory Overhead Controllable Variance
  is similar conceptually to the material price and
  labour rate variance
• Variable Factory Overhead Controllable Variance
  Actual variable overhead costs (actual activity
  base amount x variable factory overhead rate)
• 11,000 (1,900 x 5.00) 1,500 Unfavourable