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 -Often refers to cost of a single unit  Budgeted cost - Cost, at standard, of the total number of budgeted units

4. Learning objective 1: Explain how standard costs are developed Slide 11-4 Standard Costs and Budgets  If materials budget indicates purchases of 5,000 pounds, standard cost is $25,000 (5,000 pounds x $5 standard cost per pound)  If labor budget is prepared for 1,000 units produced, 3,000 labor hours are needed at total cost of $30,000

5. Learning objective 1: Explain how standard costs are developed Slide 11-5 StarbucksStarbucks

6. Learning objective 1: Explain how standard costs are developed Slide 11-6 Development of Standard Costs 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

7. Learning objective 1: Explain how standard costs are developed Slide 11-7 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. Learning objective 1: Explain how standard costs are developed Slide 11-8 Development of Standard Costs  Ideal standards assumes that no obstacles in production process, i.e.: - no breakdowns in equipment - no defects in materials  Emphasizes a perfect production environment

9. Learning objective 1: Explain how standard costs are developed Slide 11-9 Development of Standard Costs Attainable standards takes into account possible circumstances that could lead to costs greater than “ideal” It allows for:  Downtime  Inefficiencies  Waste

10. Learning objective 1: Explain how standard costs are developed Slide 11-10 Development of Standard Costs  Ideal standards - Developed under the assumption that no obstacles will be encountered - Ideal standards may not be useful for planning purposes especially if defects and breakdowns are a fact of life  Attainable standards - Take into account possibility of a variety of circumstances may lead to costs greater than ideal

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

13. Learning objective 1: Explain how standard costs are developed Slide 11-13 Development of Standard Costs

14. Learning objective 1: Explain how standard costs are developed Slide 11-14 A General Approach to Variance Analysis  Standard cost variance -Difference between a standard and an actual cost  Variance analysis - Breaking down the differences between standard and actual cost into two components, i.e. price and quantity variance

15. Learning objective 1: Explain how standard costs are developed Slide 11-15 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

16. Learning objective 1: Explain how standard costs are developed Slide 11-16 A General Approach to Variance Analysis

17. Learning objective 2: Calculate and interpret variances for direct material Slide 11-17 Material Variances  Material price variance - Difference between the actual price per unit of material and the standard price per unit of material  Material quantity variance - Difference between the actual quantity of material used and the standard quantity of material allowed for the number of units produced

18. Slide 11-18 Material Variances Learning objective 2: Calculate and interpret variances for direct material

19. Slide 11-19 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

20. Slide 11-20 You Get What You Measure! Learning objective 2: Calculate and interpret variances for direct material

21. Slide 11-21 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

22. Slide 11-22 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

23. Learning objective 3: Calculate and interpret variances for direct labor Slide 11-23 Direct Labor Variances  Labor Rate Variance -Difference between actual wage rate and standard wage rate x actual number of labor hours  Labor Efficiency Variance - Difference between actual number of hours work and standard labor hours allowed for the number of units produced x standard wage rate

24. Slide 11-24 Direct Labor Variances Learning objective 3: Calculate and interpret variances for direct labor

25. Slide 11-25 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

26. Slide 11-26 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

27. Slide 11-27 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

28. Learning objective 4: Calculate and interpret variances for manufacturing overhead Slide 11-28 Overhead Variances  Controllable overhead variance -Difference between actual amount of overhead and amount of overhead included in a flexible budget for actual production levels  Overhead volume variance - Difference between flexible overhead budget for actual level of production and overhead applied using the standard overhead rate

29. Slide 11-29 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

30. Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity Slide 11-30 Standard Cost Variance Formulas

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

32. Slide 11-32 Interpreting Overhead Volume Variance  Volume variance do not signal that overhead costs are in or out of control  Volume variance signals that more or fewer units were produced than planned when standard overhead rate developed: - Favorable: more units produced than planned - Unfavorable: fewer units produced than planned  To measure the financial impact of producing more or fewer units than planned, use incremental analysis Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity

33. Slide 11-33 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

34. Slide 11-34 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

35. Slide 11-35 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 Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity

36. Slide 11-36 Standard Cost Variances Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity

37. Learning objective 6: Discuss how the management-by-exception approach is applied to the investigation of standard cost variances Slide 11-37 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

38. 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 11-38 “Favorable” Variances May Be Unfavorable  A variance that is “favorable” should not be exempt from investigation It could indicate poor management decision  A poor decision regarding the quality of raw materials might result in an unfavorable variance in material quantity

39. Slide 11-39 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 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

40. Slide 11-40 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

41. Slide 11-41 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 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

42. Slide 11-42 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

43. Slide 11-43 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.