1. Prepared by Debby Bloom-Hill CMA, CFM

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

3. Learning objective 1: Explain how standard costs are developed Slide 11-3 Standard Costs and Budgets  Standard cost  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. Learning objective 1: Explain how standard costs are developed Slide 11-4 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. Learning objective 1: Explain how standard costs are developed Slide 11-5 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)

6. Learning objective 1: Explain how standard costs are developed Slide 11-6 StarbucksStarbucks

7. Learning objective 1: Explain how standard costs are developed Slide 11-7 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  In recipes or formulas  By time and motion studies  In price lists provided by suppliers

8. Learning objective 1: Explain how standard costs are developed Slide 11-8 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

9. Learning objective 1: Explain how standard costs are developed Slide 11-9 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

10. Learning objective 1: Explain how standard costs are developed Slide 11-10 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

11. Learning objective 1: Explain how standard costs are developed Slide 11-11 What is the primary benefit of a standard costing system? a.It records costs at what should have been incurred b.It allows a comparison of differences between actual and standard costs c.It is easy to implement d.It is inexpensive and easy to use Answer: b It allows a comparison of differences between actual and standard costs

12. Learning objective 1: Explain how standard costs are developed Slide 11-12 Standard Costing

13. Learning objective 1: Explain how standard costs are developed Slide 11-13 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 into two components

14. Learning objective 1: Explain how standard costs are developed Slide 11-14 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

15. Learning objective 2: Calculate and interpret variances for direct material Slide 11-15 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)

16. Learning objective 2: Calculate and interpret variances for direct material Slide 11-16 Material Variances  Standard for 1 unit: 400 lbs @ $10 per lb  Materials purchased: 200,000 lbs @ $9.90 per lb  Materials used: 181,000 lbs to produce 450 units

17. Slide 11-17 You Get What You Measure! Learning objective 2: Calculate and interpret variances for direct material

18. Slide 11-18 Data for chips used in the production of computers Standard: 3 chips per computer @ $6.50 per chip Quantity purchased: 200 chips for total of $1,350 Quantity used: 123 chips for production of 40 units Calculate the material price variance Learning objective 2: Calculate and interpret variances for direct material

19. Slide 11-19 Data for chips used in the production of computers Standard: 3 chips per computer @ $6.50 per chip Quantity purchased: 200 chips for $1,350 total Quantity used: 123 chips for production of 40 units Calculate the material quantity variance: Learning objective 2: Calculate and interpret variances for direct material

20. Learning objective 3: Calculate and interpret variances for direct labor Slide 11-20 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)

21. Slide 11-21 Direct Labor Variances  Standard for 1 unit: 4 hours @ $15 per hour  Actual labor: 1,700 hours @ $15.50 per hour to produce 450 units Learning objective 3: Calculate and interpret variances for direct labor

22. Slide 11-22 Data for labor used in the production of sneakers Standard:.25 hours per sneaker at $12.00 per hour Actual quantity produced: 24,500 sneakers Quantity used: 6,000 hours, total cost $69,000 Calculate the labor rate variance: Learning objective 3: Calculate and interpret variances for direct labor

23. Slide 11-23 Data for labor used in the production of sneakers Standard:.25 hours per sneaker at $12.00 per hour Actual quantity produced: 24,500 sneakers Quantity used: 6,000 hours, total cost $69,000 Calculate the labor efficiency variance : Learning objective 3: Calculate and interpret variances for direct labor

24. Learning objective 4: Calculate and interpret variances for manufacturing overhead Slide 11-24 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 and the amount of overhead applied to production using the standard overhead rate

25. Slide 11-25 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 Learning objective 3: Calculate and interpret variances for direct labor

26. Slide 11-26 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 Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity

27. Slide 11-27 Standard Cost Variance Formulas

28. Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity Slide 11-28 Standard Cost Variance Formulas

29. Slide 11-29 A favorable labor efficiency variance means: a.Labor rates were higher than called for by standards b.Inexperienced labor was used, causing the rate to be lower than standard c.More labor was used than called for by standards d.Less labor was used than called for by standards Answer: d Less labor was used than called for by standards Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity

30. Slide 11-30 What does an unfavorable overhead volume variance mean? a.Overhead costs are out of control b.Overhead costs are in control c.Production was greater than anticipated d.Production was less than anticipated Answer: d Production was less than anticipated Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity

31. Slide 11-31 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 Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity

32. Slide 11-32 Standard Cost Variances Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity

33. Learning objective 6: Discuss how the management-by-exception approach is applied to the investigation of standard cost variances Slide 11-33 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

34. Learning objective 7: Explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms of variances may lead to overproduction Slide 11-34 “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 might result in an unfavorable variance in material quantity

35. Slide 11-35 Can Process Improvements Lead to “Unfavorable” Variances?  A firm may have an unfavorable variance because it engaged in process improvements  They can lead to greater efficiency which results in actual labor hours being less than standard labor hours  Firms should stimulate greater demand to take advantage of the greater production capabilities Learning objective 7: Explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms of variances may lead to overproduction

36. Slide 11-36 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 Learning objective 7: Explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms of variances may lead to overproduction

37. Slide 11-37 Responsibility Accounting and Variances  The central idea of 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 Learning objective 7: Explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms of variances may lead to overproduction

38. Slide 11-38 QualityQuality Learning objective 7: Explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms of variances may lead to overproduction

39. Slide 11-39 CopyrightCopyright © 2010 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.