Using Variances under Standard Cost System ACG 2071 Module 10 Chapter 22 Fall 2007

Standards Are performance goals. Service, merchandising, and manufacturing businesses may all use standards to evaluate and control operations. Manufacturers normally use standard costs for each of the three manufacturing costs Direct materials Direct labor Factory overhead

Standard Cost Systems Accounting systems that use standards for these costs are called standard cost systems. Management determines how much a product should cost – Standard Cost How much it does cost – Actual Cost The causes of any differences – Variances When actual costs are compared with standard costs, only the exceptions or variances are reported for cost control. Called Principle of Exceptions. Standard costs assists management in controlling costs and in motivating employees to focus on costs.

Types of Standards Theoretical or ideal standards – achieved only under perfect conditions Currently attainable or normal standards – attained with reasonable effort

Budgetary Performance Evaluation When using standard cost system, direct materials, direct labor, and factory overhead are separated into two components A price standard A quantity standard

Standard Quantity per unit Example Assume that Halycon Balloons produced and sold 5,000 hot air balloons. It incurred direct material costs of $40,150, direct labor costs of $38,500, and factory overhead costs of $22,400. The standard costs for the company are listed below: Manufacturing Costs Standard Price Standard Quantity per unit Standard Cost per Unit Direct materials $5.00 per yard 1.5 yards $7.50 Direct labor $9.00 per hour 0.80 hour per unit $7.20 Factory overhead $6.00 $4.80 Total standard cost per unit $19.50

Budget Performance Report Manufacturing Costs Actual Costs Standard Costs at Actual Volume Cost Variance (Favorable) Unfavorable Direct materials $40,150 $37,500 $2,650 Direct labor $38,500 $36,000 $2,500 Factory overhead $22,400 $24,000 ($1,600) Total standard cost per unit $101, 050 $97,500 $3,550

Budget Performance Report Favorable cost variance occurs when the actual cost is less than the standard cost Unfavorable variance occurs when the actual cost is greater than the standard cost

Variance Analysis Types of variances Direct Materials Direct Labor Factory Overhead

Direct Materials Variance Price variance = (Actual price – Standard Price) X Actual Quantity Quantity variance = (Actual Quantity – Standard Quantity) X Actual Price Total Direct Materials Variance = Quantity Variance + Price Variance

Example Material used in the production of Z Cleaner has a standard cost of $3 per lb. and standard use of 10,000 lbs. Actual records show 15,000 lbs were used with an actual cost of $2.50 per lb. Compute the direct material variances.

Example Price Variance = (Actual Price – Standard Price) X Actual Quantity = ($2.50 – $3) X 15,000 lbs = -$0.50 X 15,000 lbs = -$7,500 favorable Quantity Variance = (Actual Quantity – Standard Quantity) X Standard Price = (15,000 lbs – 10,000 lbs) X $3.00 = 5,000 lbs x $3.00 = $15,000 Unfavorable Total direct materials variance = Quantity variance + Price variance = $15, 000 + (-$7,500) = $7,500 Unfavorable

Direct Labor Variance Rate variance = (Actual Rate – Standard Rate) X Actual Hours Time variance = ( Actual Hours – Standard Hours) X Actual Rate Total Direct Labor Variance = Time Variance + Rate Variance

Example Example 4: Factory records show that each product produced requires 3 direct labor hours. Production during the period consisted of 10,000 units with 29,500 hours of labor used. Labor has a standard cost of $10 per hour and actual cost was $11 per hour. Compute the direct labor variances.

Example Rate Variance = (Actual Rate – Standard Rate) X Actual hours = ($11 - $10) X 29,500 hours = $29,500 Unfavorable

Example Time Variance = (Actual hrs – Standard hrs) X Standard rate = [29,500 hrs – ( 3 x 10,000)] x $10 = -500 hours x $10 = -$5,000 Favorable

Example Total Direct labor variance = Rate variance + Time variance = $29,500 + (-$5,000) = $24,500 Unfavorable

Factory Overhead Variance Determine the impact of changing production on fixed and variable factory overhead cost. Variances from standard for factory overhead cost result from: Actual variable factory overhead cost greater or less than budgeted variable factory overhead for actual production Controllable variance for variable factory overhead Actual production at a level above or below 100% of normal capacity. Volume variance for fixed factory overhead

Example Percent of normal capacity 80% 90% 100% 110% Units produced   Percent of normal capacity 80% 90% 100% 110% Units produced 5,000 5,625 6,250 6,875 Direct labor hours ( .8 per unit) 4,000 4,500 5,500 Budgeted factory overhead Variable costs: Indirect factory wages $8,000 $9,000 $10,000 $11,000 Power and light Indirect materials 2,400 2,700 3,000 3,300 Total variable cost $14,400 $16,200 $18,000 $19,800 Fixed costs: Supervisory salaries $5,500 Depreciation Insurance 2,000 Total fixed cost $12,000 Total factory overhead $26,400 $28,200 $30,000 $31,800

Controllable Variance Deals with variable cost Actual variable factory overhead -Budgeted variable factory overhead* Controllable Variance *at actual production level

Example Halycon produced 5,000 balloons and each unit required 0.80 standard labor hour for production. Actual variable factory overhead was $10,400 and fixed factory overhead was $12,000 Using the information on Halycon Balloons, compute the controllable variance.

Standard direct labor hours 5,000 units produced x 0.80 per hour = 4,000 direct labor Based on units produced

Variable costs per unit = Total variable factory overhead Total hours = $18,000 = $ 3.60 per hour 5,000

Budgeted Variable Factory Overhead Standard direct labor hours for units produced x Standard variable factory overhead per DLH Budgeted variable factory overhead = 4,000 hours x $3.60 = $14,400

Controllable Variance Actual variable factory overhead $16,000 Budgeted variable factory overhead 14,400 Controllable variance $1,600 UNFAVORABLE

Volume Variance – Fixed costs 100% capacity direct labor hours -Standard direct labor hours at actual Capacity not used X standard fixed overhead rate Volume variance

Example : Using the information on Halycon Balloons, assume actual production at 80% capacity. Compute the volume variance. From the factory overhead cost budget, we compute: Fixed costs per unit = Total fixed factory overhead Total hours = $12,000 = $ 2.40 per hour 5,000 based on 100% capacity

Volume Variance 100% capacity direct labor hours 5,000 hours -Standard direct labor hours at actual 4,000 hours Capacity not used 1,000 hours X standard fixed overhead rate x $2.40 Volume Variance $2,400 unfavorable