Chapter 11 Standard Costs and Variance Analysis

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Chapter 11Standard Costs and Variance Analysis
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Presentation Outline

1. Types of Standards
2. Variance Calculations
3. Investigation of Standard Cost Variances

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I. Types of Standards

• Ideal Standards
• Can only be attained under the best
  circumstances. No allowance for machine
  breakdowns or work interruptions

• Attainable Standards
• Tight but attainable standards. Allows for
  machine downtime and employee rest periods.

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II. Variance Calculations

1. Material Price Variance
2. Material Price Variance Journal Entry
3. Material Quantity Variance
4. Material Quantity Variance Journal Entry
5. Labor Rate Variance
6. Labor Efficiency Variance
7. Journal Entry for Direct Labor Variances
8. Controllable Overhead Variance
9. Overhead Volume Variance

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A. Material Price Variance
MPV (AP SP) AQ
where
MPV Material price variance
AP Actual unit price of materials
SP Standard unit price of materials
AQ Actual quantity of materials purchased
Decision Rule
AP gt SP Unfavorable
AP lt SP Favorable
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B. Material Price Variance Journal
Entry(Recorded at Time of Purchase)
Raw Materials (AQ x SP)
XXX Materials Price Variance (AP-SP)AQ XXX
or XXX Accounts Payable (AQ x AP)
XXX
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C. Material Quantity Variance
MQV (AQ SQ) SP
where
MQV Material quantity variance
AQ Actual quantity of materials put into
production
SQ Standard quantity allowed for the output
produced
SP Standard unit price of materials
Decision Rule
AQ gt SQ Unfavorable
AQ lt SQ Favorable
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D. Material Quantity Variance Journal
Entry(Recorded when materials are put into
production)
Work in Process (SQ x SP)
XXX Materials Quantity Variance (AQ-SQ)SP
XXX or XXX Raw Materials (AQ x SP)
XXX

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E. Labor Rate Variance
LRV (AR SR) AH
where
LRV Labor rate variance
AR Actual labor rate
SR Standard labor rate
AH Actual labor hours worked
Decision Rule
AR gt SR Unfavorable
AR lt SR Favorable
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F. Labor Efficiency Variance
LEV (AH SH) SR
where
LEV Labor efficiency variance
AH Actual labor hours worked
SH Standard hours allowed for the output
produced
SR Standard labor rate
Decision Rule
AH gt SH Unfavorable
AH lt SH Favorable
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G. Journal Entry for Direct Labor Variances
Work in Process (SH x SR)
XXX Labor Rate Variance (AR-SR)AH
XXX or XXX Labor Efficiency Variance
(AH-SH)SR XXX or XXX Wages Payable
(AH x AR)
XXX
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H. Controllable Overhead Variance
Flexible budget level of overhead for the actual
level of production
Controllable overhead variance
Actual overhead

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Decision Rule
Actual gt Flexible budget Unfavorable
Actual lt Flexible budget Favorable
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I. Overhead Volume Variance
Flexible budget level of overhead for actual
level of production
Overhead applied to production using standard
overhead rate
Overhead volume variance

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Decision Rule
Flexible budget gt O/H applied Unfavorable
Flexible budget lt O/H applied Favorable
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III. Investigation of Standard Cost Variances

1. Management by Exception
2. Favorable Variances May be Unfavorable
3. Process Improvements and Unfavorable Variances
4. Variance Evaluation and Excess Production
5. Variance Analysis and Performance Evaluation

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A. Management by Exception

• Most managers take a management by exception
  approach and investigate only those variances
  that they deem to be exceptional.
• The absolute dollar value of the variance or the
  variance as a percent of actual or standard cost
  is often used as the criterion.

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B. Favorable Variances May be Unfavorable

• The fact that a variance is favorable does not
  mean that it should not be investigated. Indeed,
  a favorable variance may be indicative of poor
  management decisions. For example
• A favorable material price variance may be arisen
  from purchasing goods of inadequate quality for
  production.
• A favorable overhead volume variance could mean
  that excessive inventory has been produced beyond
  customer demand.

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C. Process Improvements and Unfavorable Variances

• Production workers suggest a change in the
  manufacturing process so that the standard for
  labor time per unit is reduced from 4 to 3 hours.
  If the company does not need to increase
  production and keeps the same number of workers,
  an unfavorable labor efficiency variance will
  arise.
• (See Illustration on page 397)

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D. Variance Evaluation and Excess Production

• The Theory of Constraints tells us that
  production departments in front of bottleneck
  departments should not produce excess
  work-in-process inventory.
• Evaluation in terms of standard cost variances
  could result in this dysfunctional behavior.
• For example, rather than lay off workers, a
  department with a temporary demand slump may
  produce excess units simply to avoid an
  unfavorable labor efficiency variance.

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E. Variance Analysis and Performance Evaluation

• Responsibility accounting states that managers
  should only be held accountable for variance that
  they can control.
• Unfavorable variances do not imply poor
  performance. For example, an unfavorable labor
  efficiency variance could result from the
  purchase of inferior goods (which by the way
  resulted in a favorable material price variance).

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Summary

• Ideal vs. Attainable Standards
• Material Variances
• Labor Variances
• Overhead Variances