2 Presentation Outline Types of Standards Variance Calculations Investigation of Standard Cost Variances
3 I. Types of Standards Ideal Standards Can only be attained under the best circumstances. No allowance for machine breakdowns or work interruptionsAttainable StandardsTight but attainable standards. Allows for machine downtime and employee rest periods.
4 II. Variance Calculations Material Price VarianceMaterial Price Variance Journal EntryMaterial Quantity VarianceMaterial Quantity Variance Journal EntryLabor Rate VarianceLabor Efficiency VarianceJournal Entry for Direct Labor VariancesControllable Overhead VarianceOverhead Volume Variance
5 A. Material Price Variance MPV = (AP – SP) AQwhere:MPV = Material price varianceAP = Actual unit price of materialsSP = Standard unit price of materialsAQ = Actual quantity of materials purchasedDecision Rule:AP > SP UnfavorableAP < SP Favorable
6 B. Material Price Variance Journal Entry (Recorded at Time of Purchase) Raw Materials (AQ x SP) XXXMaterials Price Variance [(AP-SP)AQ] XXX or XXXAccounts Payable (AQ x AP) XXX
7 C. Material Quantity Variance MQV = (AQ – SQ) SPwhere:MQV = Material quantity varianceAQ = Actual quantity of materials put into productionSQ = Standard quantity allowed for the output producedSP = Standard unit price of materialsDecision Rule:AQ > SQ UnfavorableAQ < SQ Favorable
8 D. Material Quantity Variance Journal Entry (Recorded when materials are put into production) Work in Process (SQ x SP) XXXMaterials Quantity Variance [(AQ-SQ)SP] XXX or XXXRaw Materials (AQ x SP) XXX
9 E. Labor Rate Variance LRV = (AR – SR) AH where: LRV = Labor rate varianceAR = Actual labor rateSR = Standard labor rateAH = Actual labor hours workedDecision Rule:AR > SR UnfavorableAR < SR Favorable
10 F. Labor Efficiency Variance LEV = (AH – SH) SRwhere:LEV = Labor efficiency varianceAH = Actual labor hours workedSH = Standard hours allowed for the output producedSR = Standard labor rateDecision Rule:AH > SH UnfavorableAH < SH Favorable
11 G. Journal Entry for Direct Labor Variances Work in Process (SH x SR) XXXLabor Rate Variance [(AR-SR)AH] XXX or XXXLabor Efficiency Variance [(AH-SH)SR] XXX or XXXWages Payable (AH x AR) XXX
12 H. Controllable Overhead Variance Flexible budget level of overhead for the actual level of productionControllable overhead varianceActual overhead=-Decision Rule:Actual > Flexible budget UnfavorableActual < Flexible budget Favorable
13 I. Overhead Volume Variance Flexible budget level of overhead for actual level of productionOverhead volume varianceOverhead applied to production using standard overhead rate=-Decision Rule:Flexible budget > O/H applied UnfavorableFlexible budget < O/H applied Favorable
14 III. Investigation of Standard Cost Variances Management by Exception“Favorable” Variances May be UnfavorableProcess Improvements and “Unfavorable VariancesVariance Evaluation and Excess ProductionVariance Analysis and Performance Evaluation
15 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.
16 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.
17 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)
18 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.
19 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).
20 Ideal vs. Attainable Standards SummaryIdeal vs. Attainable StandardsMaterial VariancesLabor VariancesOverhead Variances