14-1 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Standard Costing: A Managerial Control Tool 14 PowerPresentation® prepared by David J. McConomy, Queen’s University

14-2 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Learning Objectives l Explain how unit standards are set and why standard cost systems are adopted. l Explain the purpose of a standard cost sheet. l Describe the basic concepts underlying variance analysis and explain when variances should be investigated.

14-3 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Learning Objectives (continued) l Compute the materials and labour variances and explain how they are used for control. l Compute the variable and fixed overhead variances and explain their meaning. l Use variance analysis as an analytical tool for profitability analysis. (Appendix A)

14-4 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Learning Objectives (continued) l Prepare journal entries for materials and labour variances and describe the accounting for overhead variances. (Appendix B)

14-5 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Unit Standard Cost To determine the unit standard cost for a particular input, two decisions must be made: 1. How much of the input should be used per unit of output ? (Quantity decision) 2.How much should be paid for the quantity of the input to be used ? (Pricing decision)

14-6 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Types of Standards Ideal Standards demand maximum efficiency and can be achieved only if everything operates perfectly. Currently attainable standards can be achieved under efficient operating conditions.

14-7 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Sources for Quantitative Standards 1.Historical experience 2.Engineering studies 3.Input from operating personnel

14-8 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Factors for Price Standards - Materials 1. Market forces 2. Quality 3. Discounts 4. Freight

14-9 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Factors for Price Standards - Labour 1. Market forces 2. Trade unions 3. Payroll taxes 4. Qualifications

14-10 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Purposes of Standards l To improve planning and control l To facilitate product costing

14-11 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Cost Assignment Approaches Cost Assignment Approaches Manufacturing CostsDirect MaterialslabourOverhead Actual costing systemActualActualActual Normal costing systemActualActualBudgeted Standard costing systemStandardStandardStandard

14-12 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. A Standard Cost Sheet StandardStandardStandard DescriptionPriceUsageCost/Unit Direct materials $1.50/kg.10 kgs.$15.00 Direct labour $6.00/hr.2 hours12.00 Variable overhead $10.00/hr.2 hours20.00 Fixed Overhead 1 $8.00/hr.2 hours $63.00 Other Operating Data for Period: Units produced 20,000 units 210,000 kilograms $1.55 per kilogram; 205,000 kgs. used Direct labour costs 39,000 $6.10 per hour Variable overhead $410,000 1 Fixed overhead $300,000; Rate = ($310,000/38,750 hrs)

14-13 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Variable Cost Variance Analysis: General Description Actual Quantity of Input at Actual Price AQ x AP Actual Quantity of Input at Standard Price AQ x SP Standard Quantity of Input at Standard Price SQ x SP Price Variance AQ x (AP - SP) Usage Variance SP x (AQ - SQ) Budget Variance (AQ x AP) - (SQ x SP)

14-14 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Variance Investigation Variances are investigated if two conditions are met: 1. The variance is material 2. The benefits of investigating and taking corrective action are greater than its costs

14-15 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Control Limits: Standard + Allowable Deviation Investigating occurs for values outside the allowable range. Example: Assume the allowable deviation may be the lesser of $8,000 or 10% of the standard. Suppose the standard is $50,000 and the actual deviation from standard is $6,000. Will the variance be investigated. Answer: Yes. Ten percent of standard is $5,000. Since $6,000 is larger than the allowable deviation, an investigation will take place.

14-16 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Material Variances Formula Approach: MPV = (AP - SP)AQ MUV = (AQ - SQ)SP = ($1.55-$1.50)210,000 = (205, ,000)$1.50 = $10,500 U = $7,500U Diagram Approach: AQ x AP AQ x SP AQ x SP SQ x SP 210,000 x $ ,000 x $ ,000 x $ ,000 x $1.50 MPV = $10,500U MUV = $7,500U Flexible Budget Variance = $18,000U Responsibility: Responsibility: Purchasing Manufacturing SQ = 20,000 units x 10 lbs per unit

14-17 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Labour Variances Formula Approach: LRV = (AR - SR)AH LEV= (AH - SH)SR = ($ $6.00)39,000 = (39, ,000)$6.00 = $3,900 U = $6,000 F Diagram Approach: AH x AR AH x SR SH x SR 39,000 x $ ,000 x $ ,000 x $6.00 LRV = $3,900 U LEV = $6,000 F Flexible Budget Variance = $2,100 F Responsibility: Responsibility: Human Resources Manufacturing SQ = 20,000 units x 2 hrs. per unit

14-18 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Variable Overhead Variances Formula Approach: OSV = (AVOR - SVOR)AH OEV = (AH - SH)SVOR = $410,000 - ($10 X 39,000 hrs) = (39, ,000)$10.00 = $20,000 U = $10,000 F Diagram Approach: AH x AVOR AH x SVOR SH x SVOR $410,000 39,000 x $ ,000 x $10.00 OSV = $20,000 U OEV = $10,000 F Flexible Budget Variance = $10,000 U Responsibility: Responsibility: Manufacturing Manufacturing SQ = 20,000 units x 2 hrs. per unit

14-19 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Fixed Overhead Variances Actual Overhead Budgeted Overhead Applied Overhead $300,000 $310,000 SOR x SH ($8 x40,000) OSV = $10,000F DV = 10,000F Responsibility: Responsibility: Manufacturing Difficult to Assess Alternative Approach for Computing FOH Denominator Variance Planned level 38,750hrs. Applied level (SOR) 40,000hrs. Over 1,250hrs. x $8 FOH Denominator Variance $10,000F ======

14-20 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. APPENDIX A

14-21 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Further Analysis of the Profit Volume Variance l The profit volume variance can be decomposed further, for example into industry volume and market share variances l In the next slide, assume that the master budget was based on a certain percentage of market share, and that the industry experienced an increase in its volume of 10%

14-22 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Profit Variances from Chapter 13

14-23 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Industry Volume and Market Share Variances

14-24 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Sales Mix Variance l Assume that the previous statement was for a multi-product company, and that its budgeted CMR at its budgeted mix was l Assume further that the actual sales mix would have resulted in a budgeted CMR of 0.58 instead l How much is the Sales Mix Variance? Answer: x 80,000 = $ -1,600 U The following spreadsheet includes a comprehensive analysis of all profit variances

14-25 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Profit Variances - A Comprehensive Analysis

14-26 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Profitability Analysis: Problem Total CM per Master Budget A9,000 x $8 = $72,000 B6,500 x 11 = 71,500$143,500 Total standard CM for Actual Quantities A10,000 x $8 = $80,000 B 6,000 x 11 = 66,000$146,000 Profit Volume Variance (gross) 2,500 F =======

14-27 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Profitability Analysis : Problem (continued) 2. Weighted average CM per unit based on Master Budget $143,500/15,500 = Total standard CM for Actual Quantity146,000 Total standard CM for 16,000 units assuming budgeted sales mix 16,000 x $ ,129 Sales mix variance $ 2,129 U Profit volume variance (net) (16, ,500) x $ = 4,629 F

14-28 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Profitability Analysis: Problem (continued) 3. Decline in industry sales (77, ,000) x 77,500 = 17.42% Industry volume variance.1742 x 15,1500 x = $24,997 U Budgeted market share: 15,500/77,500 = 20% Market share variance (16,000-[0.20 x 64,000]) x = $29,626 F 4. Sales Price Variance A10,000($ ) = 10,000 F B 6,000($ ) = 12,000 F$22,000 F

14-29 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Profitability Analysis: Problem (continued) 5. Variable cost flexible budget variances Variable manufacturing costs A10,000($ ) = 10,000 U B 6,000($ ) = 12,000 U = $22,000 U Variable marketing and administrative A10,000($ ) = 1,000 U B 6,000($ ) = 600 U = $ 1,600 U $23,600 U 6. Fixed cost flexible budget variance Manufacturing 36, ,500 = 1,500 U Mktg and admin 44, ,000 = 4,000 U $5,500 U

14-30 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Profitability Analysis: Problem (continued) 7. Budgeted net income $69,000 Industry volume variance$24,997 U Market share variance 29,626 F Profit volume variance (net) 4,629 F Sales mix variance 2,129 U Profit Volume Variance (gross) 2,500 F Sales price variance$22,000 F Variable cost flex. bud. var.$23,600 U Fixed cost flex. bud. var. 5,500 U Total profit variances$ 4,600U Actual net income $ 64,400

14-31 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. APPENDIX B

14-32 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Accounting for Variances Journal Entry for Purchase of Direct Materials Materials (AQ x SP)315,000 MPV (AP - SP)AQ 10,500 Accounts Payable (AQ x AP)325,500 Rule: Unfavourable variances are recorded by a debit and favourable variances are recorded by a credit.

14-33 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Accounting for Variances (continued) Recording the Issuance of Materials to Production Work in Process (SQ x SP)300,000 MUV [(AQ - SQ)SP] 7,500 Materials (AQ x SP)307,500 AQ = Actual quantity used in production

14-34 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Accounting for Variances (continued) Recording the Direct Labour Costs Work in Process (SH x SR)240,000 LEV [(AH - SH) SR] 3,900 Accrued Payroll (AH x AR)237,900 LRV [(AR - SR) AH]6,000

14-35 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Accounting for Variances (continued) Recording Variable Overhead Work in Process (SQ x SP) 400,000 Manufacturing Applied (SQ x SP)400,000 Manufacturing Overhead (Actual)410,000 Various Accounts410,000

14-36 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Accounting for Variances (continued) Recording Fixed Overhead Work in Process (SQ x SP)320,000 Manufacturing Overhead Applied320,000 Manufacturing Overhead (Actual)300,000 Various Accounts300,000

14-37 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Accounting for Variances (continued) Recording O/H Variances and Closing the O/H Accounts Manufacturing O/H Applied (Variable) 400,000 Manufacturing O/H Applied (Fixed) 320,000 OSV (Variable) 20,000 Manufacturing Overhead (Variable) 410,000 Manufacturing Overhead (Fixed) 300,000 OEV (Variable) 10,000 OSV (Fixed) 10,000 DV (Fixed) 10,000

14-38 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Accounting for Variances (continued) Disposition of Overhead Variances OEV (Variable) 10,000 OSV (Fixed)10,000 DV (Fixed)10,000 OSV (Variable) 20,000 Cost of Goods Sold 10,000