CHAPTER 11CHAPTER 11CHAPTER 11CHAPTER 11
Standard Costs and Variance Standard Costs and Variance AnalysisAnalysis
Standard Costs and Variance Standard Costs and Variance AnalysisAnalysis
Standard Costs and Standard Costs and BudgetsBudgets
Standard Costs and Standard Costs and BudgetsBudgets
Standard Cost The cost that management believes
should be incurred to produce a product or service under anticipated conditions
Often refers to the cost of a single unit
Budgeted Cost The cost, at standard, of the total
number of budgeted units
StarbucksStarbucksStarbucksStarbucks
Development of Standard Development of Standard CostsCosts
Development of Standard Development of Standard CostsCosts
The standard quantity and price for material may be specified: In engineering plans that provide a list of material In recipes or formulas By time and motion studies In price lists provided by suppliers
The standard quantity and rate for direct labor may be specified: By time and motion studies Through analysis of past data By management expectations of rates to be paid In contracts that set labor rates
Standard costs for overhead involves procedures similar to those used to develop predetermined overhead rates
Development of Standard Development of Standard CostsCosts
Development of Standard Development of Standard CostsCosts
Ideal Standards Assumes that no obstacles will be
encountered in the production process
– No breakdowns in equipment– No defects in material
Emphasizes a perfect production environment
Attainable Standards Takes into account possible
circumstances that could lead to costs greater than “ideal”
Study Break #1Study Break #1Study Break #1Study Break #1
What is the primary benefit of a standard costing system?a. It records costs at what should have
been incurredb. It allows a comparison of differences
between actual and standard costsc. It is easy to implementd. It is inexpensive and easy to use
Answer:b. It allows a comparison of differences between actual and standard costs
Study Break #2Study Break #2Study Break #2Study Break #2
Which of the following is not a way to develop a standard cost?a. By using a fixed rate that is higher
every periodb. By performing time and motion studiesc. By analyzing past datad. By using what is specified in
engineering plans
Answer:a. By using a fixed rate that is higher every period
A General Approach to A General Approach to Variance AnalysisVariance Analysis
A General Approach to A General Approach to Variance AnalysisVariance Analysis
Standard Cost Variance The difference between a standard and an
actual cost
Variance Analysis Breaking down the differences between
standard and actual cost into two components
Direct material variances– Material price variance– Material quantity variance
Direct labor variances– Labor rate variance– Labor efficiency variance
Manufacturing overhead variances– Overhead volume variance– Controllable overhead variance
Material VariancesMaterial VariancesMaterial VariancesMaterial Variances
Material Price Variance Difference between the actual price
per unit of material and the standard price per unit of material
Formula = (AP – SP)AQp
Actual > Standard = Unfavorable
Actual < Standard = Favorable
Material VariancesMaterial VariancesMaterial VariancesMaterial Variances
Material Quantity Variance Difference between the actual
quantity of material used and the standard quantity of material allowed for the number of units produced
Formula = (AQu – SQ)SP
Actual > Standard = Unfavorable
Actual < Standard = Favorable
You Get What You Measure!You Get What You Measure!You Get What You Measure!You Get What You Measure!
Example Exercise #1Example Exercise #1Example Exercise #1Example Exercise #1 Crain Computer Company purchased 200
M30 chips for $6.75 each to be used in the production of its CC2140 computer. Standards call for 3 chips for each computer. The standard price for the M30 chip is $60. In July, the company purchased 200 chips for $1,350. The company used 123 chips in the production of 40 computers (3 chips were damaged in the installation process).
Calculate the material price variance and the material quantity variance related to the M640 and indicate if the variances are favorable or unfavorable.
Example Exercise #1 Example Exercise #1 SolutionSolution
Example Exercise #1 Example Exercise #1 SolutionSolution
Material Price Variance
Actual Price = $1,350/200 = $6.75= (AP - SP) AQP = ($6.75 - $60) 200= ($10,650) favorable
Example Exercise #1 Example Exercise #1 SolutionSolution
Example Exercise #1 Example Exercise #1 SolutionSolution
Material Quantity Variance
Standard Quantity = 40 x 3 = 120= (AQU - SQ) SP= (123* - 120) $60= $180 unfavorable
*120 standard quantity + 3 damaged units
Direct Labor VariancesDirect Labor VariancesDirect Labor VariancesDirect Labor Variances
Labor Rate Variance Difference between the actual wage
rate and the standard wage rate multiplied by the actual number of labor hours
Formula = (AR – SR)AH
Actual > Standard = Unfavorable
Actual < Standard = Favorable
Direct Labor VariancesDirect Labor VariancesDirect Labor VariancesDirect Labor Variances
Labor Efficiency Variance Difference between the actual number of
hours work and the standard labor hours allowed for the number of units produced multiplied by the standard wage rate
Formula = (AH – SH)SR
Actual > Standard = Unfavorable
Actual < Standard = Favorable
Example Exercise #2Example Exercise #2Example Exercise #2Example Exercise #2
The standard labor cost for the production of a pair of Tukor Brand athletic shoes is .25 hours at $12 per hour. During the month of June, 24,500 pairs of athletic shoes were produced. Actual labor costs were $73,500 for 7,000 hours.
For June, compute the labor rate and labor efficiency variances.
Example Exercise #2 Example Exercise #2 SolutionSolution
Example Exercise #2 Example Exercise #2 SolutionSolution
Labor Rate Variances
Actual wage rate = $73,500 ÷ 7,000 hours = $10.50 per hour
= (AR - SR) AH = ($10.50 - $12) 7,000= ($10,500) favorable
Example Exercise #2 Example Exercise #2 SolutionSolution
Example Exercise #2 Example Exercise #2 SolutionSolution
Labor Efficiency Variances
Standard hours = 24,500 .25 hours per pair = 6,125 hours
= (AH - SH) SR= (7,000 - 6,125) $12= $10,500 unfavorable
Overhead VariancesOverhead VariancesOverhead VariancesOverhead Variances
Controllable Overhead Variance Difference between actual amount
of overhead the amount of overhead included in a flexible budget for actual production levels
Overhead Volume Variance Difference between flexible budget
for overhead for actual level of production and overhead applied using the standard overhead rate
Example Exercise #3Example Exercise #3Example Exercise #3Example Exercise #3 Barret Hospital is interested in
analyzing overhead related to laundry services. The hospital administrator estimated that monthly fixed costs would be $75,000 and variable costs would be $2.50 per patient day. During the month of September, the hospital had 15,000 patient days. Total laundry costs were $115,000.
Calculate the controllable overhead variance and determine if it is favorable or unfavorable.
Example Exercise #3 Example Exercise #3 SolutionSolution
Example Exercise #3 Example Exercise #3 SolutionSolution
Controllable Overhead Variance
= Actual overhead - Flexible budget level of overhead for actual production
= $115,000 - [$75,000 + ($2.50 15,000)]
= $115,000 - $112,500= $2,500 unfavorable
Standard Cost Variance Standard Cost Variance FormulasFormulas
Standard Cost Variance Standard Cost Variance FormulasFormulas
Capacity Variations and the Capacity Variations and the Financial ImpactFinancial Impact
Capacity Variations and the Capacity Variations and the Financial ImpactFinancial Impact
Volume variance only signals that more or fewer units were produced than planned when the standard overhead rate was set Favorable variance when more units
produced than planned Unfavorable variance when fewer units
produced than planned Does not measure financial impact of
operating at more or less than capacity
To measure the financial impact of producing more or fewer units than planned, use incremental analysis
Study Break #3Study Break #3Study Break #3Study Break #3 What does a favorable labor efficiency variance mean?a. Labor rates were higher than called for
by standardsb. Inexperienced labor was used, causing
the rate to be lower than standardc. More labor was used than called for by
standardsd. Less labor was used than called for by
standards
Answer:d. Less labor was used than called for by standards
Study Break #4Study Break #4Study Break #4Study Break #4
What does an unfavorable overhead volume variance mean?a. Overhead costs are out of controlb. Overhead costs are in controlc. Production was greater than
anticipatedd. Production was less than anticipated
Answer:d. Production was less than anticipated
Investigation of Standard Cost Investigation of Standard Cost VariancesVariances
Investigation of Standard Cost Investigation of Standard Cost VariancesVariances
Standard Cost Variances do not provide definitive evidence
Should be viewed as an indicator of potential problem areas
Must investigate facts behind the variances
Standard Cost VariancesStandard Cost VariancesStandard Cost VariancesStandard Cost Variances
Management by ExceptionManagement by ExceptionManagement by ExceptionManagement by Exception
Investigation of standard cost variances is a costly activity
Investigate only those variances that are considered exceptional
Must determine criteria to measure what is considered exceptional Absolute dollar value Percent of actual or standard cost
““Favorable” Variances May Be Favorable” Variances May Be UnfavorableUnfavorable
““Favorable” Variances May Be Favorable” Variances May Be UnfavorableUnfavorable
A variance that is “favorable” should not be exempt from investigation
Could indicate poor management decisions
A poor decision regarding the quality of raw materials might result in an unfavorable variance in material quantity
Can Process Improvements Can Process Improvements Lead to “Unfavorable” Lead to “Unfavorable”
Variances?Variances?
Can Process Improvements Can Process Improvements Lead to “Unfavorable” Lead to “Unfavorable”
Variances?Variances? Process improvements can lead to
greater efficiency in production
Greater efficiency results in actual labor hours being less than standard labor hours
Firms should stimulate greater demand to take advantage of the greater production capabilities
Evaluation in Terms of Evaluation in Terms of Variances Can Lead to Excess Variances Can Lead to Excess
ProductionProduction
Evaluation in Terms of Evaluation in Terms of Variances Can Lead to Excess Variances Can Lead to Excess
ProductionProduction When bottlenecks exist, the
department in front of the bottleneck should not produce more than the bottlenecked department can handle
If it does it will create excess work-in-process inventory and result in a negative impact on shareholder value
Responsibility Accounting and Responsibility Accounting and VariancesVariances
Responsibility Accounting and Responsibility Accounting and VariancesVariances
Managers should be held responsible for only the costs they can control
Additionally, managers and workers should only be held responsible for variances they can control
QualityQualityQualityQuality
CopyrightCopyrightCopyrightCopyright© 2007 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.