2. Standard Costs and Variance Analysis
CHAPTER 11
Standard Costs and Variance Analysis

3. Standard Costs and Budgets
The cost that management believes should be incurred to produce a product or service under anticipated conditions
Often refers to the cost of a single unit
Budgeted Cost
The cost, at standard, of the total number of budgeted units

4. Starbucks

5. Development of Standard Costs
The standard quantity and price for material may be specified:
In engineering plans that provide a list of material
In recipes or formulas
By time and motion studies
In price lists provided by suppliers
The standard quantity and rate for direct labor may be specified:
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

6. Development of Standard Costs
Ideal Standards
Assumes that no obstacles will be encountered in the production process
No breakdowns in equipment
No defects in material
Emphasizes a perfect production environment
Attainable Standards
Takes into account possible circumstances that could lead to costs greater than “ideal”

7. Study Break #1
What is the primary benefit of a standard costing system?
It records costs at what should have been incurred
It allows a comparison of differences between actual and standard costs
It is easy to implement
It is inexpensive and easy to use
Answer:
b. It allows a comparison of differences between actual and standard costs

8. Study Break #2
Which of the following is not a way to develop a standard cost?
By using a fixed rate that is higher every period
By performing time and motion studies
By analyzing past data
By using what is specified in engineering plans
Answer:
a. By using a fixed rate that is higher every period

9. A General Approach to Variance Analysis
Standard Cost Variance
The difference between a standard and an actual cost
Variance Analysis
Breaking down the differences between standard and actual cost into two components
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

10. Material Variances Material Price Variance Formula = (AP – SP)AQp
Difference between the actual price per unit of material and the standard price per unit of material
Formula = (AP – SP)AQp
Actual > Standard = Unfavorable
Actual < Standard = Favorable

11. Material Variances Material Quantity Variance Formula = (AQu – SQ)SP
Difference between the actual quantity of material used and the standard quantity of material allowed for the number of units produced
Formula = (AQu – SQ)SP
Actual > Standard = Unfavorable
Actual < Standard = Favorable

12. You Get What You Measure!

13. Example Exercise #1
Crain Computer Company purchased 200 M30 chips for $6.75 each to be used in the production of its CC2140 computer. Standards call for 3 chips for each computer. The standard price for the M30 chip is $60. In July, the company purchased 200 chips for $1,350. The company used 123 chips in the production of 40 computers (3 chips were damaged in the installation process).
Calculate the material price variance and the material quantity variance related to the M640 and indicate if the variances are favorable or unfavorable.

14. Example Exercise #1 Solution
Material Price Variance
Actual Price = $1,350/200 = $6.75
= (AP - SP) AQP
= ($ $60) 200
= ($10,650) favorable

15. Example Exercise #1 Solution
Material Quantity Variance
Standard Quantity = 40 x 3 = 120
= (AQU - SQ) SP
= (123* - 120) $60
= $180 unfavorable
*120 standard quantity + 3 damaged units

16. Direct Labor Variances
Labor Rate Variance
Difference between the actual wage rate and the standard wage rate multiplied by the actual number of labor hours
Formula = (AR – SR)AH
Actual > Standard = Unfavorable
Actual < Standard = Favorable

17. Direct Labor Variances
Labor Efficiency Variance
Difference between the actual number of hours work and the standard labor hours allowed for the number of units produced multiplied by the standard wage rate
Formula = (AH – SH)SR
Actual > Standard = Unfavorable
Actual < Standard = Favorable

18. Example Exercise #2
The standard labor cost for the production of a pair of Tukor Brand athletic shoes is .25 hours at $12 per hour. During the month of June, 24,500 pairs of athletic shoes were produced. Actual labor costs were $73,500 for 7,000 hours.
For June, compute the labor rate and labor efficiency variances.

19. Example Exercise #2 Solution
Labor Rate Variances
Actual wage rate = $73,500 ÷ 7,000 hours = $10.50 per hour
= (AR - SR) AH
= ($ $12) 7,000
= ($10,500) favorable

20. Example Exercise #2 Solution
Labor Efficiency Variances
Standard hours = 24,500  .25 hours per pair = 6,125 hours
= (AH - SH) SR
= (7, ,125) $12
= $10,500 unfavorable

21. Overhead Variances Controllable Overhead Variance
Difference between actual amount of overhead the amount of overhead included in a flexible budget for actual production levels
Overhead Volume Variance
Difference between flexible budget for overhead for actual level of production and overhead applied using the standard overhead rate

22. Example Exercise #3
Barret Hospital is interested in analyzing overhead related to laundry services. The hospital administrator estimated that monthly fixed costs would be $75,000 and variable costs would be $2.50 per patient day. During the month of September, the hospital had 15,000 patient days. Total laundry costs were $115,000.
Calculate the controllable overhead variance and determine if it is favorable or unfavorable.

23. Example Exercise #3 Solution
Controllable Overhead Variance
= Actual overhead - Flexible budget level of overhead for actual production
= $115,000 - [$75,000 + ($2.50  15,000)]
= $115,000 - $112,500
= $2,500 unfavorable

24. Standard Cost Variance Formulas

25. Capacity Variations and the Financial Impact
Volume variance only signals that more or fewer units were produced than planned when the standard overhead rate was set
Favorable variance when more units produced than planned
Unfavorable variance when fewer units produced than planned
Does not measure financial impact of operating at more or less than capacity
To measure the financial impact of producing more or fewer units than planned, use incremental analysis

26. Study Break #3 What does a favorable labor efficiency variance mean?
Labor rates were higher than called for by standards
Inexperienced labor was used, causing the rate to be lower than standard
More labor was used than called for by standards
Less labor was used than called for by standards
Answer:
d. Less labor was used than called for by standards

27. Study Break #4 What does an unfavorable overhead volume variance mean?
Overhead costs are out of control
Overhead costs are in control
Production was greater than anticipated
Production was less than anticipated
Answer:
d. Production was less than anticipated

28. Investigation of Standard Cost Variances
Standard Cost Variances do not provide definitive evidence
Should be viewed as an indicator of potential problem areas
Must investigate facts behind the variances

29. Standard Cost Variances

30. Management by Exception
Investigation of standard cost variances is a costly activity
Investigate only those variances that are considered exceptional
Must determine criteria to measure what is considered exceptional
Absolute dollar value
Percent of actual or standard cost

31. “Favorable” Variances May Be Unfavorable
A variance that is “favorable” should not be exempt from investigation
Could indicate poor management decisions
A poor decision regarding the quality of raw materials might result in an unfavorable variance in material quantity

32. Can Process Improvements Lead to “Unfavorable” Variances?
Process improvements can lead to greater efficiency in production
Greater efficiency results in actual labor hours being less than standard labor hours
Firms should stimulate greater demand to take advantage of the greater production capabilities

33. Evaluation in Terms of Variances Can Lead to Excess Production
When bottlenecks exist, the department in front of the bottleneck should not produce more than the bottlenecked department can handle
If it does it will create excess work-in-process inventory and result in a negative impact on shareholder value

34. Responsibility Accounting and Variances
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

35. Quality

36. Copyright
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