 # Standard Costs and Variance Analysis

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Standard Costs and Variance Analysis
CHAPTER 11 Standard Costs and Variance Analysis

Standard Costs and Budgets
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

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Development of Standard Costs
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: 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 Costs
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 #1 What is the primary benefit of a standard costing system? It records costs at what should have been incurred It allows a comparison of differences between actual and standard costs It is easy to implement It is inexpensive and easy to use Answer: b. It allows a comparison of differences between actual and standard costs

Study Break #2 Which of the following is not a way to develop a standard cost? By using a fixed rate that is higher every period By performing time and motion studies By analyzing past data By using what is specified in engineering plans Answer: a. By using a fixed rate that is higher every period

A General Approach to Variance 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 Variances Material Price Variance Formula = (AP – SP)AQp
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 Variances Material Quantity Variance Formula = (AQu – SQ)SP
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!

Example 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 Solution
Material Price Variance Actual Price = \$1,350/200 = \$6.75 = (AP - SP) AQP = (\$ \$60) 200 = (\$10,650) favorable

Example Exercise #1 Solution
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 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 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 #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 Solution
Labor Rate Variances Actual wage rate = \$73,500 ÷ 7,000 hours = \$10.50 per hour = (AR - SR) AH = (\$ \$12) 7,000 = (\$10,500) favorable

Example Exercise #2 Solution
Labor Efficiency Variances Standard hours = 24,500  .25 hours per pair = 6,125 hours = (AH - SH) SR = (7, ,125) \$12 = \$10,500 unfavorable

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 #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 Solution
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 Formulas

Capacity Variations and the Financial 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 #3 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 Answer: d. Less labor was used than called for by standards

Study Break #4 What does an unfavorable overhead volume variance mean?
Overhead costs are out of control Overhead costs are in control Production was greater than anticipated Production was less than anticipated Answer: d. Production was less than anticipated

Investigation of Standard Cost Variances
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 Variances

Management 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 Unfavorable
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 Lead to “Unfavorable” 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 Variances Can Lead to Excess Production
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 Variances
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

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