Production Cost Variance Analysis 20 Production Cost Variance Analysis

Variances Variance: Difference between two numbers, typically, actual and a performance standard. Variance analysis decomposes a variance into factors that caused variance.

Direct Material Variances Actual cost - standard cost = (act qty * act pr) - (Std qty * std pr) = mat. price variance + mat. usage variance. Materials price variance = act qty * std pr - act qty *act pr = (standard price -actual price) * actual quantity = price * actual quantity. Materials usage (yield or quantity) variance = (std qty * std pr) - (act qty * std pr) = (std qty - act qty) * standard price = quantity * standard price.

Direct Labor Variances Analyzed same as direct material variances. Total standard (actual) direct labor in an accounting period = (standard (actual) labor cost per unit of output) * (output produced in period). Direct labor cost variance = total standard labor content of goods actually produced – total actual labor cost.

DL Variance Decomposed Labor efficiency (= labor quantity = labor usage) variance = (standard time – actual time) * (standard rate) = time * standard rate. Labor rate (=labor price) variance = (actual hourly rate – standard hourly rate) * actual hours worked = rate * actual time.

DL Variances Production supervisors responsible for: Labor efficiency variance. Probably not for labor rate variance. Variances may be interdependent: By using higher skilled workers, labor rate variance may be unfavorable but labor efficiency variance may be favorable.

Standard Overhead Rate Absorbed by production (i.e. charged to WIP): Predetermined overhead rate X actual level of production. Predetermined overhead rate = (total overhead cost estimated to be incurred at standard level of volume)  (estimated or standard or normal production activity level).

Flexible Overhead Budget Total overhead cost: TC = TFC + ((UVC*X). Where TC = total cost, TFC = total fixed cost, UVC = unit variable cost, X production volume, in units. Overhead rate, R, at standard volume, S: R = (TFC + (UVC * S)) / S.

Overhead (= net overhead) variance (overhead costs actually incurred) – (overhead costs absorbed by, that is, charged to, production) Actual overhead costs: Increase (dr. to) the Overhead Clearing account. Absorbed overhead costs: Decrease (cr. to) same account. Overhead variance: Remaining balance in Overhead Clearing.

Overhead Variance Decomposition 2 elements: Production volume variance. Spending variance.

Production volume variance Caused by actual production volume differing from standard volume. Budgeted costs = absorbed costs, only at standard volume. Below (above) standard volume: Overhead absorbed is less (more) than budgeted cost Bud. OH costs are under-absorbed (over-absorbed). Production volume variance is unfavorable (favorable) or a debit (credit) balance. Not related to amount of actual costs incurred. Total absorbed overhead cost = AC = R*X.

Spending variance (flexible budgeted overhead costs for period’s actual level of production) - (period’s actual overhead costs). Favorable (unfavorable) when actual costs are below (above) budget. Similar in significance to the sum of usage and price variances for DM & DL costs. Ordinarily examined on an item by item basis without further decomposition. Can be decomposed for some overhead items (e.g. electricity, supplies) into usage and price components.

Sales volume Plays no role in accounting for production overhead, direct material, and direct labor costs.

Summary of variance calculations (1 of 2) Absorbed: Standard overhead rate * Actual Volume = R * Actual Volume. Budgeted: Flexible overhead budget at actual volume = budgeted fixed costs + (budgeted unit variable costs) * (actual volume). Actual overhead: Actual costs incurred in the period (and charged to Overhead Clearing account).

Summary of variance calculations (2 of 2) Net overhead variance = Absorbed – Actual. Volume variance = Absorbed – Budgeted. Spending variance = Budgeted – Actual.

Uses for Overhead Variances Identifies differences between expectations and actual results. A starting point for asking questions. Who controls variance in question: purchasing, production, marketing, HR managers? Generally based on current year’s planned volume. Seasonality, vacation schedules, and different lengths of fiscal months result in monthly planned (and actual) volumes not equaling 1/12 of the annual planned volume. Thus, volume variances may be planned for some months. Sum of volume variances equals zero. (If budget and standards based on same production level.)

Idle Capacity Costs Fixed costs of production viewed as incurred to maintain a certain capacity. Normal volume is defined as practical capacity not expected volume. Practical capacity = theoretical capacity less downtime. Holidays, etc. Idle capacity variance = (actual volume – practical capacity)*(fixed costs/practical capacity) Negative variance indicates amount of fixed cost wasted because capacity was underutilized.

20 End of Chapter 20