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PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Standard.

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Presentation on theme: "PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Standard."— Presentation transcript:

1 PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Standard Costs and Variances Chapter 10 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

2 10-2 Standard Costs Standards are benchmarks or norms for measuring performance. In managerial accounting, two types of standards are commonly used. Quantity standards specify how much of an input should be used to make a product or provide a service. Price standards specify how much should be paid for each unit of the input. Examples: Firestone, Sears, McDonalds, hospitals, construction, and manufacturing companies.

3 10-3 Standard Costs Direct Material Deviations from standards deemed significant are brought to the attention of management, a practice known as management by exception. Type of Product Cost Amount Direct Labor Manufacturing Overhead Standard

4 10-4 Variance Analysis Cycle

5 10-5 Setting Standard Costs Should we use ideal standards that require employees to work at 100 percent peak efficiency? Engineer Managerial Accountant I recommend using practical standards that are currently attainable with reasonable and efficient effort.

6 10-6 Setting Direct Materials Standards Standard Price per Unit Summarized in a Bill of Materials. Final, delivered cost of materials, net of discounts. Standard Quantity per Unit

7 10-7 Setting Direct Labor Standards Use time and motion studies for each labor operation. Standard Hours per Unit Often a single rate is used that reflects the mix of wages earned. Standard Rate per Hour

8 10-8 Setting Variable Manufacturing Overhead Standards The rate is the variable portion of the predetermined overhead rate. Price Standard The quantity is the activity in the allocation base for predetermined overhead. Quantity Standard

9 10-9 A General Model for Variance Analysis Variance Analysis Price Variance Difference between actual price and standard price Quantity Variance Difference between actual quantity and standard quantity

10 10-10 Quantity and Price Standards Quantity and price standards are determined separately for two reasons: The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used. The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production.

11 10-11 Variance Analysis Materials price variance Labor rate variance VOH rate variance Materials quantity variance Labor efficiency variance VOH efficiency variance A General Model for Variance Analysis Quantity VariancePrice Variance

12 10-12 A General Model for Variance Analysis Actual quantity is the amount of direct materials, direct labor, and variable manufacturing overhead actually used. Quantity Variance (2) – (1) Price Variance (3) – (2) (1) Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP) (2) Actual Quantity of Input, at Standard Price (AQ × SP) (3) Actual Quantity of Input, at Actual Price (AQ × AP) Spending Variance (3) – (1)

13 10-13 A General Model for Variance Analysis Standard quantity is the standard quantity allowed for the actual output of the period. Quantity Variance (2) – (1) Price Variance (3) – (2) (1) Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP) (2) Actual Quantity of Input, at Standard Price (AQ × SP) (3) Actual Quantity of Input, at Actual Price (AQ × AP) Spending Variance (3) – (1)

14 10-14 A General Model for Variance Analysis Actual price is the amount actually paid for the input used. Quantity Variance (2) – (1) Price Variance (3) – (2) (1) Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP) (2) Actual Quantity of Input, at Standard Price (AQ × SP) (3) Actual Quantity of Input, at Actual Price (AQ × AP) Spending Variance (3) – (1)

15 10-15 A General Model for Variance Analysis Quantity Variance (2) – (1) Price Variance (3) – (2) (1) Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP) (2) Actual Quantity of Input, at Standard Price (AQ × SP) (3) Actual Quantity of Input, at Actual Price (AQ × AP) Spending Variance (3) – (1) Standard price is the amount that should have been paid for the input used.

16 10-16 Materials Price VarianceMaterials Quantity Variance Production Manager Purchasing Manager The standard price is used to compute the quantity variance so that the production manager is not held responsible for the purchasing managers performance. Responsibility for Materials Variances

17 10-17 Responsibility for Labor Variances Production Manager Production managers are usually held accountable for labor variances because they can influence the: Mix of skill levels assigned to work tasks. Level of employee motivation. Quality of production supervision. Quality of training provided to employees.

18 10-18 Advantages of Standard Costs Management by exception Advantages Promotes economy and efficiency Simplified bookkeeping Enhances responsibility accounting

19 10-19 Potential Problems Emphasis on negative may impact morale. Emphasizing standards may exclude other important objectives. Favorable variances may be misinterpreted. Continuous improvement may be more important than meeting standards. Standard cost reports may not be timely. Invalid assumptions about the relationship between labor cost and output. Potential Problems with Standard Costs

20 10-20 FPOHR = Fixed portion of the predetermined overhead rate DH = Denominator hours SH = Standard hours allowed for actual output SH × FR DH × FR Fixed Overhead Volume Variance Volume variance FPOHR × (DH – SH) = Fixed Overhead Applied Actual Fixed Overhead Budgeted Fixed Overhead Volume variance

21 10-21 Budget variance Fixed Overhead Budget Variance Budget variance Budgeted fixed overhead Actual fixed overhead =– Fixed Overhead Applied Actual Fixed Overhead Budgeted Fixed Overhead

22 10-22 Reconciling Overhead Variances and Underapplied or Overapplied Overhead In a standard cost system: Unfavorable variances are equivalent to underapplied overhead. Favorable variances are equivalent to overapplied overhead. The sum of the overhead variances equals the under- or overapplied overhead cost for the period.

23 10-23 Cost Flows in a Standard Cost System Inventories are recorded at standard cost. Variances are recorded as follows: Favorable variances are credits, representing savings in production costs. Unfavorable variances are debits, representing excess production costs. Standard cost variances are usually closed out to cost of goods sold. Unfavorable variances increase cost of goods sold. Favorable variances decrease cost of goods sold. Inventories are recorded at standard cost. Variances are recorded as follows: Favorable variances are credits, representing savings in production costs. Unfavorable variances are debits, representing excess production costs. Standard cost variances are usually closed out to cost of goods sold. Unfavorable variances increase cost of goods sold. Favorable variances decrease cost of goods sold.

24 10-24 End of Chapter 10


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