1. Prepared by Debby Bloom-Hill CMA, CFM

2. CHAPTER 11
Standard Costs
and
Variance Analysis

3. Standard Costs and Budgets
Cost that management believes should be incurred to produce a product or service under anticipated conditions.
Standard costs can be used by manufacturing and service companies.
A tool manufacturer may set a standard cost for producing a hammer.
A bank may set a standard cost for processing a check.

4. Standard Costs and Budgets
The term standard cost often refers to the cost of a single unit.
The term budgeted cost often refers to the cost, at standard, of the total number of budgeted units.
The cost information contained in budgets must be consistent with standard costs.

5. Standard Costs and Budgets
If materials budget indicates purchases of 5,000 pounds, standard cost is $25,000 (5,000 pounds * $5 standard cost per pound).
If labor budget is prepared for 1,000 units produced, 3,000 labor hours are needed at a standard cost of $30,000 (3,000 hours * $10).
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6. Development of Standard Costs
Standard costs for material, labor and overhead are developed in a variety of ways.
Standard quantity and price for material may be specified:
In engineering plans that provide a list of material (bill of material).
In recipes or formulas.
In price lists provided by suppliers.

7. Development of Standard Costs
Standard quantity and rate for direct labor may be specified:
By time and motion studies.
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.

8. Ideal versus Attainable Standards
In developing standard costs, some managers emphasize ideal standards while others use attainable standards.
Ideal standards assumes that no obstacles to the production process will be encountered.
Managers who support ideal standards believe they motivate employees to strive for the best possible control over production costs.

9. Ideal versus Attainable Standards
Attainable standards are standard costs that take into account the possibility that a variety of circumstances may lead to costs that are greater than ideal.
If equipment breakdowns and defects are a fact of life, it makes sense to plan for their associated costs.
Most managers support the use of attainable standards.

10. A General Approach to Variance Analysis
Companies that use standard costing can analyze the difference between a standard and an actual cost.
Called a standard cost variance.
Determines whether operations are being performed efficiently.
The analysis is called variance analysis.
It generally involves breaking down the differences between standard and actual cost for direct material, direct labor and manufacturing overhead into into two components.

11. A General Approach to Variance Analysis
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.

12. Material Variances Material price variance:
Difference between the actual price per unit of material (AP) and the standard price per unit of material (SP) times the actual quantity of material purchased (AQ).
Material quantity variance:
Difference between the actual quantity of material used (AQ) and the standard quantity of material allowed for the number of units produced (SQ) times the standard price of material (SP).

13. Material Variances Standard for 1 unit: 400 lbs @ $10 per lb.
Materials purchased: 200,000 $9.90 per lb.
Materials used: 181,000 lbs to produce 450 units.
AQP = Actual quantity purchased AQU = Actual quantity used SQ = Standard quantity for the actual level of production
AP = Actual price SP = Standard price
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14. Direct Labor Variances
Labor Rate Variance:
Difference between actual wage rate (AR) and standard wage rate (SR) times the actual number of labor hours worked (AH).
Labor Efficiency Variance:
Difference between actual number of hours worked (AH) and the standard labor hours allowed for the number of units produced (SH) times the standard labor wage rate (SR).

15. Direct Labor Variances
Standard for 1 unit: 4 $15 per hour.
Actual labor: 1,700 $15.50 per hour to produce 450 units.
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16. Overhead Variances Controllable overhead variance:
Difference between the actual amount of overhead and amount of overhead that would be included in a flexible budget for the actual level of production.
Overhead volume variance:
Difference between the amount of overhead included in the flexible budget for the actual level of production and the amount of overhead applied to production using the standard overhead rate.

17. Overhead Variances Standard for 1 unit: $50 overhead applied.
Actual overhead: $23,000 to produce 450 units.
Flexible budget overhead: $15,000 fixed + $20 per unit produced.
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18. Interpreting Overhead Volume Variance
Volume variances do not signal that overhead costs are in or out of control.
A volume variance signals that the quantity of production was greater or less than anticipated.
The usefulness of the volume variance is limited.
It signals only that more or fewer units have been produced than planned when the standard overhead rate was set.

19. Investigation of Standard Cost Variances
Standard cost variances do not provide definitive evidence that costs are out of control and managers are not performing effectively.
They should be viewed as an indicator of potential problem areas.
The only way to determine whether costs are being effectively controlled is to investigate the facts behind the variances.

20. Management by Exception
Investigation of standard cost variances is a costly activity.
A management by exception approach is to investigate only those variances that are considered exceptional.
Must determine criteria to measure what is considered exceptional.
Absolute dollar value of the variance.
The variance as a percent of actual or standard cost.

21. “Favorable” Variances May Be Unfavorable
The fact that a variance is favorable does not mean that is should not be investigated.
A favorable variance may be indicative of poor management decisions.
A poor decision regarding the quality of raw materials purchased resulting in a favorable material price variance might result in an unfavorable material quantity variance and/or an unfavorable labor efficiency variance.

22. Responsibility Accounting and Variances
The central principle behind responsibility accounting is that 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.

23. Copyright
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