Chapter Eleven

1
Chapter Eleven

• STANDARD COSTS AND VARIANCE ANALYSIS

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Objectives

• Explain how standard costs are developed.
• Calculate and interpret variances for direct
  materials.
• Calculate and interpret variances for direct
  labor.
• Calculate and interpret variances for
  manufacturing overhead.
• Calculate the impact on costs of operating at
  more or less than planned capacity.

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Objectives (Continued)

• Discuss how the management by exception approach
  is applied to investigation of standard cost
  variances.
• Explain why even favorable variances may need to
  be investigated and why care must be take in
  interpreting variances.

4
Standard Costs

• Standard cost refers to expected costs under
  anticipated conditions.
• Standard cost systems allow for comparison of
  standard versus actual costs.
• Differences are referred to as standard cost
  variances.
• Variances should be investigated if significant.

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Standard Costs and Budgets

• Standard cost is the standard cost of a single
  unit.
• Budgeted cost is the cost, at standard, of the
  total number of budgeted units.

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Development of Standard Costs

• Standard costs are developed in a variety of
  ways
• Specified by formulas or recipes.
• Developed from price lists provided by suppliers.
• Determined by time and motion studies conducted
  by industrial engineers.
• Developed from analyses of past data.

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Ideal Versus Attainable Standards

• Ideal standards (perfection standards) assume
  that no obstacles to the production process will
  be encountered.
• Attainable Standards developed under the
  assumption that there will be occasional problems
  in the production process.

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A General Approach To Variance Analysis

• Direct material materials price and materials
  quantity variance.
• Direct labor labor rate (price) and labor
  efficiency (quantity) variance.
• Overhead overhead volume variance and
  controllable overhead variance.

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Material Variances

• Differences between standard and actual material
  costs
• Material price variance.
• Material quantity variance.

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Material Price Variance

• COMPARES THE ACTUAL PRICE (AP) PAID FOR
  MATERIALS TO THE STANDARD PRICE (SP) FOR THE
  QUANTITY OF MATERIALS PURCHASED (AQp) .
• Material price variance (AP SP) x AQp
• UNFAVORABLE (U) if the actual price gt standard
  price
• FAVORABLE (F) if the actual price lt standard
  price
• THIS ALSO MAY BE COMPUTED AS ACTUAL COST OF
  PURCHASES MINUS SP X AQp.

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Material Quantity Variance

• COMPARES THE ACTUAL QUANTITY OF MATERIALS USED
  (AQu) FOR MATERIALS TO THE STANDARD QUANTITY
  ALLOWED (SQ) FOR THE QUANTITY OF MATERIALS
  EVALUATED AT THE STANDARD PRICE. (SP)
• Material quantity variance (AQu SQ) x SP
• UNFAVORABLE (U) if the actual quantity gt
  standard price.
• FAVORABLE (F) if the actual quantity lt standard
  price.
• THE STANDARD QUANTITY ALLOWED IS THE STANDARD
  QUANTITY PER UNIT TIMES THE NUMBER OF UNITS
  PRODUCED.

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Direct Labor Variances

• Differences between standard and actual direct
  labor costs due to
• Labor rate (price) variance.
• Labor efficiency (quantity) variance.

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Labor Rate Variance

• COMPARES THE ACTUAL WAGE RATE (AR) PAID FOR
  LABOR TO THE STANDARD RATE (SR) FOR THE QUANTITY
  OF LABOR USED (AH).
• Labor rate variance (AR SR) x AH
• UNFAVORABLE (U) if the actual rate gt standard
  rate
• FAVORABLE (F) if the actual rate lt standard
  rate
• THIS ALSO MAY BE COMPUTED AS ACTUAL DIRECT
  LABOR COSTS MINUS SR X SH.

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Labor Efficiency Variance

• COMPARES THE ACTUAL LABOR HOURS USED (AH) TO THE
  STANDARD QUANTITY OF HOURS ALLOWED (SH)
  EVALUATED AT THE STANDARD WAGE RATE. (SR)
• Labor efficiency variance (AH SH) x SR
• UNFAVORABLE (U) if the actual hours gt standard
  hours.
• FAVORABLE (F) if the actual hours lt standard
  hours.
• THE STANDARD QUANTITY OF HOURS ALLOWED IS THE
  STANDARD HOURS PER UNIT TIMES THE NUMBER OF UNITS
  PRODUCED.

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Overhead Variances

• Differences between actual overhead costs and
  overhead applied to inventory at standard
  overhead costs are due to
• Controllable overhead variances.
• Overhead volume variance.

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Controllable Overhead Variances

• Compare actual overhead costs to flexible budget
  overhead costs for the actual volume of
  production.
• Referred to as controllable because managers are
  expected to control costs.
• UNFAVORABLE (U) if the actual cost gt flexible
  budget.
• FAVORABLE (F) if the actual cost lt flexible
  budget.
• sum of controllable overhead variances for
  individual costs is the total controllable
  variance.

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CONTROLLABLE OVERHEAD VARIANCES

• The controllable overhead variances can be
  analyzed into price and efficiency components.
• Example the electric utility bill may have an
  unfavorable variance because we used too many KW
  hours, or because of a rate hike.
• The sum of controllable overhead variances for
  individual costs is the total controllable
  overhead variance.

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Overhead Volume Variance

• Overhead volume variance compares the flexible
  budget level of overhead for actual level of
  production output to applied overhead using the
  standard overhead rate.
• This variance is solely the result of a different
  number of units being produced than planned in
  the static budget.
• Unfavorable indicates underutilized capacity
• Favorable indicates overutilized capacity.

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Measuring The Financial Impact Of Operating At
More or Less Than Planned Capacity

• Operating at less than planned capacity results
  in an unfavorable variance equal to the number of
  units (less than planned) x the standard fixed
  cost per unit.
• Operating at more than planned capacity results
  in a favorable variance equal to the number of
  units (more than planned) x the standard fixed
  cost per unit.

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Comprehensive Example Darrington Ice Cream

• Standard Costs Per Unit
• Item Qty. x Price Total
• Direct Materials .8 gal. 2.50 2.00
• Direct Labor .125 hrs. 12.00 1.50
• Mfg. Overhead .75
• Total Cost Per Unit (Standard) 4.00

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Comprehensive Example Darrington Ice Cream
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Material Variances

• Material price variance(AP SP) x AQp (2.72
  - 2.50) x 810,000 178,200 unfavorable.
• Material quantity variance (AQu SQ)SP
  (809,000 800,000) x 2.50 22,500 unfavorable.

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Labor Variances

• Labor rate (price) variance (AR SR)AH (12.10
  - 12.00) x 130,000 13,000 unfavorable.
• Labor efficiency (quantity) variance(AH
  SH)SR (130,000 125,000) x 12 60,000
  unfavorable.

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Overhead Variances

• Controllable overhead variance Actual overhead
  () - flexible budget level of overhead () for
  the actual volume of production 680,000 -
  700,000 20,000 favorable.
• Overhead volume variance flexible budget level
  of overhead for actual level of production -
  overhead applied to production using standard
  overhead rate 700,000 - 750,000 50,000
  favorable.

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Investigation of Standard Cost Variances

• Standard cost variances are not a definitive sign
  of good or bad performance.
• Large Variances are merely indicators of
  potential problems which should be investigated.
• There are many plausible explanations for them.

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Management By Exception

• Investigation of standard cost variances is a
  costly activity
• Management must decide which variances to
  investigate.
• Most managers practice management by exception.
• What is exceptional? Usually an absolute dollar
  amount or a percentage amount. For example the
  policy may be to investigate variances that are
  more than 10 above or below standard.

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Favorable Variances May Be Unfavorable

• A favorable variance does not mean that it
  should not be investigated.
• For example a favorable raw materials price
  variance may indicate inferior quality materials
• As a result there may be substantially more scrap
  and rework, which would show up as unfavorable
  quantity and efficiency variances.

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Responsibility Accounting and Variances

• Managers should be held responsible only for
  costs they can control.
• This is also true in the area of variance
  analysis.
• Sometimes areas of responsibility overlap.
• A purchasing agent will be held responsible for
  direct material price variances, but what about
  material quantity (usage) variances?

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Appendix Recording Standard Costs

• Accounting information systems can be designed to
  routinely measure cost variances for materials,
  labor and overhead.
• Inventory accounts are kept at standard cost,
  making inventory accounting easier
• Variance accounts are closed periodically either
  to cost of goods sold or to income summary.

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Recording Material Costs

• Purchase of raw materials inventory (perpetual
  system)
• Account dr. cr.
• Raw Material Inventory (std.) xxx
• Material Price Variance x
• Accounts Payable (actual) xxxx
• Usage of raw materials inventory
• Account dr. cr.
• Work in Process Inventory xxx
• Material Quantity Variance x
• Raw Material Inventory xxxx
• Unfavorable variances

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Recording Labor Costs

• Recording Labor Cost
• Account dr. cr.
• Work in Process Inventory (std.) xxx
• Labor Rate Variance x
• Labor Efficiency Variance x
• Wages/Sal. Payable (actual) xxxxx
• unfavorable variances

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Recording Manufacturing Overhead Step 1

• To record actual overhead cost
• Account dr. cr.
• Manufacturing Overhead Control xxxxx
• Various Accounts xxxxx
• indirect labor, utilities, supplies, insurance,
  depreciation, supervisory costs etc.

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Recording Manufacturing Overhead Step 2

• To apply overhead cost to work in process
  inventory at standard cost
• Account dr. cr.
• Work in Process Inventory xxx
• Manufacturing Overhead xxx

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Recording Manufacturing Overhead Step 3

• To identify variances and close manufacturing
  overhead control account
• Account dr. cr.
• Overhead Volume Variance x
• Controllable Overhead Variance(s) x
  Manufacturing Overhead xx
• Unfavorable (they would be a credit if
  favorable)

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Recording Finished Goods and Cost of Goods Sold

• To record completed units sent to finished goods
• Account dr. cr.
• Finished Goods Inventory xxxxx
• Work in Process Inventory xxxxx
• To record cost of goods sold
• Account dr. cr.
• Cost of Goods Sold xxxxx
• Finished Goods Inventory xxxxx

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Closing Variance Accounts

• Temporary variance accounts must be closed at the
  end of the period.
• Account dr. cr.
• Cost of Goods Sold xxxxxx
• Overhead Volume Variance x
• Controllable Overhead Variance x
• Material Price Variance x
• Material Quantity Variance x
• Labor Rate Variance x
• Labor Efficiency Variance x
• This example assumes all variances were
  unfavorable

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Quick Review Question 1

• What does an unfavorable overhead volume variance
  mean?
• Overhead costs are out of control.
• Overhead costs are under control.
• Production was greater than anticipated.
• Production was less than anticipated.

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Quick Review Question 1

• What does an unfavorable overhead volume variance
  mean?
• Overhead costs are out of control.
• Overhead costs are under control.
• Production was greater than anticipated.
• Production was less than anticipated.

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Quick Review Question 2

• Standard material costs per unit are 3.50.
  Actual costs per unit are 3.80 Actual quantity
  is 3,000. Standard quantity is 2,800. Material
  price variance is
• 900 favorable
• 900 unfavorable
• 700 favorable
• 700 unfavorable

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Quick Review Question 2

• Standard material costs per unit are 3.50.
  Actual costs per unit are 3.80 Actual quantity
  is 3,000. Standard quantity is 2,800. Material
  price variance is
• 900 favorable
• 900 unfavorable
• 700 favorable
• 700 unfavorable

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Quick Review Question 3

• 3. Standard material costs per unit are 3.50.
  Actual costs per unit are 3.80 Actual quantity
  is 3,000. Standard quantity is 2,800. Material
  quantity variance is
• 900 favorable
• 900 unfavorable
• 700 favorable
• 700 unfavorable

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Quick Review Question 4

• What does a favorable labor efficiency variance
  mean?
• Labor rates were higher than called for by
  standards.
• Inexperienced labor was used, causing the rate to
  be lower than standard.
• More labor was used than called for by standards.
• Less labor was used than called for by standards.

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Quick Review Question 4

• What does a favorable labor efficiency variance
  mean?
• Labor rates were higher than called for by
  standards.
• Inexperienced labor was used, causing the rate to
  be lower than standard.
• More labor was used than called for by standards.
• Less labor was used than called for by standards.