(c) ghanendra fago (m. phil, mba) 1 standard costing, variance analysis and management cycle use...
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(C) Ghanendra Fago (M. Phil, MBA) 1
Standard Costing, Variance Analysis and Management CycleUse standard costs to prepare budgets and establish goals for product costing.
Apply dollar, time, and quantity standards to work.
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(C) Ghanendra Fago (M. Phil, MBA) 2
Standard Costs
1. Standard costs are predetermined costs
that are developed from analyses of both:1. a. Past operating costs, quantities, and times
2. b. Future costs and operating conditions.
2. In a standard costing system, standard
costs for direct materials, direct labor, and
manufacturing overhead flow through the
inventory accounts and eventually into the
Cost of Goods Sold account.
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The Management Cycle
Managers use standard costs throughout the management cycle:
• In the planning stage of the management cycle, standard costs aid in the development of budgets.
• During the executing stage, standard costs, quantities, and time are applied to work performed.
• During the reviewing stage, actual costs are compared with standard costs to compute variances, and managers analyze the causes of those variances to improve operations.
• During the reporting stage, a variance report provides information on operations and managerial performance
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The Management Cycle
In today’s globally competitive environment, new standards or measurements are necessary to help managers:– Reduce processing time. – Improve quality.– Improve customer satisfaction.– Improve on-time deliveries
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Standard Costs• Standard costs are used with existing job
order or process costing systems. • Standard costs are usually expressed as the
cost per unit of a finished product or process.
– Standard costs are based on:
– Engineering estimates.
– Forecasted demand.
– Worker input.
– Time and motion studies.
– Type and quality of direct materials
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Standard Costing• The technique for application of standard cost is known
as Standard Costing. It is the preparation of standard cost
and applying them to measure the variation between
standard cost and actual cost.
• The preparation of standard costs of products and service
and a technique whereby the planned activities of an
undertaking are expressed in budgets, standard costs,
standard selling price and standard profit margins, and
the differences between these and the comparable actual
results are accounted for.’
• Standard costing is expensive to use because the
management accounting system must keep separate
records of actual costs to compare with what should have
been spent.
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Standard costing may be summarized as
• To fix the standard cost for material, labour and overhead.
• To find out the actual cost• To compare the actual cost with standard cost• To analyse the variance between standard
cost and actual cost
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Use of Standard Costs Preparing operating budgets.
Identifying production costs and processes that
must be managed to reduce waste and
inefficiency.
Evaluating the performance of managers and
workers.
Setting prices.
Simplifying inventory and product costing
procedures
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Standard Cost per UnitThere are six standards used to determine the
standard cost per unit:
1.1. Direct materials price standardDirect materials price standard
2.2. Direct materials quantity standardDirect materials quantity standard
3.3. Direct labor time standardDirect labor time standard
4.4. Direct labor rate standardDirect labor rate standard
5.5. Standard variable manufacturing overhead rateStandard variable manufacturing overhead rate
6.6. Standard fixed manufacturing overhead rateStandard fixed manufacturing overhead rate
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Direct Materials Price Standard The direct materials price standard is found by carefully considering: – Expected price increases– Changes in available quantities.– Possible new sources of supply.
Direct Materials Quantity StandardThe direct materials quantity standard is affected by:– Product engineering specifications.– Quality of direct materials.– Age and productivity of machines.– Quality and experience of the work force.
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Direct Labor Time Standard The direct labor time standard is based on current
time and motion studies of workers and machines
and past performance.
Direct Labor Rate Standard The direct labor rate standards are affected by
labor union contracts and company personnel
policies.
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Standard Direct Materials, Standard Direct Labor Costs Manufacturing Overhead Costs
Standard Direct Materials Cost
= Direct Materials Price Standard X
Direct Materials Quantity Standard
Standard Direct Labor CostStandard Direct Labor Cost
= = Direct Labor Time Standard X Direct Direct Labor Time Standard X Direct
Labor Rate Standard Labor Rate Standard
Standard Manufacturing Overhead Cost
= (Standard Variable Overhead Rate
+Standard Fixed Overhead Rate) X
Application Basis
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Standard RatesStandard Variable Manufacturing Overhead Rate
= Total budgeted variable manufacturing overhead costs ÷ Expected number of standard machine hours
Standard Fixed Manufacturing Overhead RateStandard Fixed Manufacturing Overhead Rate= Total budgeted fixed manufacturing overhead= Total budgeted fixed manufacturing overhead
costs ÷Normal capacity in terms of costs ÷Normal capacity in terms of standard standard machine hoursmachine hours
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Standard Unit Cost
• A product’s standard unit cost is determined by
adding standard direct materials cost, standard
direct labor cost and standard manufacturing
overhead rate.
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Four Step Approach of Variance Analysis
1. Compute the variance. If the variance is
insignificant, actual operating results are close
to or equal to anticipated operation conditions,
no corrective action is needed.
2. Determine the cause of any significant variance.
3. Identify the performance measures that track
those activities.
4. Take action to correct the problem or continue
to improve operations.
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Using Variance Analysis to Control Costs
Compute Variance
No CorrectiveAction Needed
NoIs the Variance Material Significant?
Take Corrective Action
Determine Cause(s)of Variance
Yes
Identify and Analyze Performance Measures
to DetermineCorrective Action
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Material Variance Analysis The term variance refers to the deviation of the actual
cost from the standard cost due to the various causes.
Variances will occur if in any given production period the actual costs vary from the standard costs.
"Cost variance is the difference between the standard cost and the comparable actual cost incurred during a given period“ : ICMA
For example, if the price paid for material bought during a given production period, differed from the standard (expected) price for that material, a material price variance will arise.
Similarly if the amount of material actually used exceeded the standard (expected) usage a material usage variance will arise.
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Material Cost VarianceThe difference between material at the standard material price and actual material price is known as material usage variance. The variance can be favorable or unfavorable .If the actual cost is lower than the standard cost, it is considered as a favorable variance and if the actual cost exceeds the standard cost the difference is deemed to be unfavorable.
• Material Cost Variance (MCV):• = SQSP–AQAP
= (SQ*SP)-(AQ*AP)= ((SQ/SO*AO)*SP)-(AQ*AP)
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Material Price Variance (MPV)• Material price variance is the deviation of the
actual price paid from the standard price specified.Formula:
• Material Price Variance (MPV)= AQ (SP–AP)
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Possible Causes of Direct Materials Price Variance
• Changes in vendor prices, inaccurate or
outdated direct materials price standards, and
differences between the quality of direct
materials purchased and the quality desired.
• Differences between quantity discounts
received and those anticipated.
• The purchase of substitute direct materials
that differ from product specifications.
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Material Usage Variance (MUV)
• It indicates the difference between the standard
quantities of the material specified from the actual
quantity of output and actual quantities of material
used .The material usage variance can be calculated
by multiplying the difference between the actual
quantity and standard quantity by standard price.
Formula:
• Material Usage Variance (MUV) = SP*(SQ-AQ)
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Material Mix Variance (MMV)
The material mix variance is the result of the
deviation of the actual composition of a mixture
of the material from the standard one. Normally, a
material mix variance arises where there is the
change in the composition of the material mixture
Formula:
Material Mix Variance (MMV) = (Total Weight of
AM/Total weight of SM)(SC of SM)–SC of AM
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Possible causes of a direct materials quantity variance
• Inaccurate or outdated direct materials quantity standards
• Poor workmanship or excellent workmanship
• Faulty equipment
• Inferior or superior quality of direct materials
• Poor materials handling
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Material Yield Variance (MYV)• The difference between the standard yield output)
specified and actual yield (output) obtained
• This variance is based on the output of the product
• The standard loss during its processing is expected to
be 15%.
Formula:
Material yield variance (MYV): (Actual yield or output-
Standard yield or output for actual input)*Standard cost
per unit = SC/SO (Actual Yield –standard Yield)
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Material Cost Variance (MCV)
Material Price Variance (MPV)
Material Usage Variance (MUV)
Material Mix Variance (MMV)
Material Yield Variance (MYV)
VERIFICATION
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Direct Cost Variance (LCV)
Is the difference between the standard direct labor
cost for the actual output and the actual labor cost
paid. The deviation of the actual direct wages paid from
the direct wages specified for the standard output.
Formula: Labour Cost Variance (LCV)
= ST SR – AT A
= ((ST/SO AO)*SR) -(AT AR)
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Labor Rate (wage) Variance Difference between standard wage rate per
hour/day/week/month/fixed and actual wage rate paid.
It is usually caused due to increases in wage rate
because of negotiation with the union or other
causes.
Labour Rate Variance = AT (SR – AR)
Causes of Direct Labor Rate Variance
• A worker is hired at a pay rate that is higher or lower
than expected.
• An employee performed the duties of a higher- or
lower-paid position.
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Labor Efficiency Variance (LEV)
• “Have the workers performed as efficiently as they were expected to perform”?
• It compares the quantity of work achieved in the time paid for, with the production that should have been achieved in that time if the labor force had worked according to standard timings.
Labour Efficiency Variance (LEV) = SR (ST – AT)
Causes of Direct Labor Efficiency Variance
• Overall wage rates changed due to New labor agreements, labor strikes that cause the temporary hiring of unskilled help, large layouts that result in unusual usage of remaining workers etc.
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Favorable Direct Labor Efficiency
Variance A favorable direct labor efficiency variance can be caused by
improved training of employees, new machinery and higher
quality of materials.
Unfavorable Direct Labor Efficiency
VarianceAn unfavorable direct labor efficiency variance can be caused
by machine breakdowns, inferior direct materials, poor
supervision, slow materials handling, and poor employee
performance
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Labor Mix Variance (MMV)
It is possible when more than one type of labor
is used for the job.
It represents the variance due to the change in
standard and actual labor force composition.
Labour Mix Variance (LMV) = (Total AT
Mix/Total ST Mix)– SC of AM
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Labor Yield Variance (LYV)
It represents that portion of labor efficiency
variance which is due to difference between the
standard output and the actual output.
If the actual labor output is higher as compare
to the relative standard, then variance would be
favorable and vice versa
Labour Yield Variance (LYV)= SR (Actual Yield
or Output – Standard Yield for Actual Input i.e.
Time)
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Labor Idle Time Variance (LITV) Sub efficiency variance.
Indicates the standard cost of the actual hours
for which the employees may remain idle due to
abnormal circumstances like strikes, lockouts,
power failure, breakdown of machinery,
unavailability or raw materials etc.
Always unfavorable.
For the accurate of the labor efficiency variance
labor, idle time should be adjusted.
Labour Idle Time Variance = Idle Time SR (U)