Standard Costing: It is a system of cost ascertainment & control in which predetermined standard cost & income for products

& operation are set & periodically compared with actual cost incurred & income generated in order to establish any variances. Standard cost is an estimated or predetermined cost of performing an operation or producing a good or service, under normal conditions. Relevant cost: A cost that differs between alternatives in a particular decision. This termed as synonymous with avoidable cost & differential cost. Sunk cost: a sunk cost is a cost that has already been incurred & that cannot be change by any decision made now or in the future. Since sunk cost cannot be changed by any decision there not differential cost. Therefore they can & should be ignored when making a decision. Sunk costs are always the same, no matter what alternatives are being considered, and they are therefore always irrelevant & should be ignored. Budget: A Budget is a plan that outlines an organization's financial and operational goals. So a budget may be thought of as an action plan; planning a budget helps a business allocate resources, evaluate performance, and formulate plans. What is Flexible budget? How does it differ from static budget? Flexible budget is a budget that is designed to cover a range of activity and that can be used to develop budgeted costs at any point within that range to compare to actual costs incurred. A flexible budget can be adjusted to reflect any level of activity. When a flexible budget is used in performance evaluation, actual costs are compared to what the costs should have been for the actual level of activity during the period rather than to the budgeted costs from the original budget. If the factory actually produced 10,000 units, then management should compare actual factory costs for 10,000 units to what the factory should have spent to make 10,000 units, not to what the factory should have spent to make 9,000 units or 11,000 units or any other production level.A flexible budget can be adjusted to reflect any level of activity. By contrast, a static budget is prepared for a single level of activity and is not subsequently adjusted. What is Static budget? A static budget is a budget created at the beginning of the budgeting period that is valid only for the planned level of activity. It is suitable for planning purposes, but it is inadequate for evaluating how well costs are controlled. It is a budget prepared for a single level of activity that remains unchanged even if the activity level subsequently changes. Difference between static budget and flexible budget: 1) The budget which is prepared at the beginning of the period and is valid for only the planned level of activity is called static budget. / The budget which provides estimates of what cost should be for any level of activity is called flexible budget. 2) It is for planned level of activity. / It is for actual level of activity. 3) In static budget, it is inadequate for evaluating how well costs are controlled. / In flexible budget, it is adequate to control cost. 4) It is not suitable for the variable cost. / It is important distinction for variable cost. 5) If the actual activity differs from the budgeted planned level, it would mislead to compare the cost to the static budget. / Different actual activity can compared to the different level of activity. Standard budgets: Standard budgets present information at only one level of activity and do not provide information on how the variable portion of the costs would affect the budget. When used in Variance Analysis this can lead to unfavorable variances being falsely identified. It is equal to standard activity x standard rate. Variance Analysis:

Variance is the difference between what is expected and the actual. it is the difference between "should take" and "did take". The deviation from the actual is called variance. Variance can be of two types positive and negative. It is the analysis of variance in a standard costing & budgetary control in order to seek their causes. Expenditure, usage & efficiency variances are typical parameters to be examined in variance analysis. Variance is also used in performance evaluation. Materials Price Variance: Materials price variance is the difference between the actual purchase price and standard purchase price of materials. Materials price variance is calculated either at the time of purchase of direct materials or at the time when the direct materials are used. Material Price Variance = (AP SP) AQ. Materials quantity variance: Materials quantity variance or materials usage variance measures the difference between the actual quantity of materials used in production and the standard quantity allowed, multiplied by the standard price per unit of materials. Material Quantity or Usage Variance = (AQ SQ) SP. Labor Rate Variance: It is a measure of the difference between the actual hourly labor rate and the standard rate, multiplied by the number of hours worked during the period. Labor Rate Variance = (Standard Rate Actual Rate) Actual hour worked. Labor Efficiency Variance: It is a measure of the difference between the actual hours taken to complete a task and the standard hours allowed, multiplied by the standard hourly labor rate. Labor Efficiency Variance = (Standard Hours Actual hours excluding idle time) Standard Rate. Variable Overhead Spending Variance: It is the difference between the actual variable overhead cost incurred during a period and the standard cost that should have been incurred based on the actual activity of the period. Variable overhead spending variance = (AH AR) - (AH SR). Interpretation: The interpretation of the variable-overhead spending variance is that a different total amount was spent on variable overhead than should have been spent in accordance with the variable-overhead rate, given the actual level of the cost driver upon which the variable-overhead budget is based. For example, if direct labor hours are used to budget variable overhead, an unfavorable spending variance means that a greater total amount was spent on variable overhead than should have been spent, after adjusting for how much actual direct-labor time was used. The spending variance is the control variance for variable overhead. Variable Overhead Efficiency Variance: It is the difference between the actual activity (direct labor hours, machine hours or some other base) and the standard activity allowed, multiplied by the standard variable overhead cost per unit. Efficiency variance = (actual quantity - standard quantity) standard variable overhead cost per unit. The efficiency variance is unfavorable if the actual quantity exceeds the standard quantity: it is favorable if the actual quantity is less than the standard. Interpretation: The interpretation of the variable-overhead efficiency variance is related to the efficiency in using the activity upon which variable overhead is budgeted. For example, if the basis for the variable-overhead budget is direct-labor hours, an unfavorable variableoverhead efficiency variance will result when the actual direct-labor hours exceed the standard allowed direct-labor hours. Thus, the variable-overhead efficiency variance will disclose no information about the efficiency with which variable-overhead items are used. Rather, it results from inefficiency or efficiency, relative to the standards, in the usage of the cost driver (such as direct-labor hours).

Fixed Overhead Budget Variance: The budget variance is the difference between the actual fixed overhead costs incurred during the period & the original budgeted fixed overhead costs for the period. Formula of Budget variance= actual fixed overhead cost - Budgeted fixed overhead cost. Interpretation: The budget variances for fixed overhead can be very useful, since they represent the difference between how much should have been spent according to the budget and how much was actually spent. If actual costs exceed budgeted costs, the variance is labeled unfavorable. Fixed Overhead Volume Variance: It is the variance that arises whenever the standard hours allowed for the output of a period are different from the denominator activity level that was used to compute the predetermined overhead rate. It is important to note that the volume variance does not over-or-under spending. In short, the volume variance is an activity related variance. It is explainable only by activity & its controllable only through activity. Formula of Volume variance = Fixed portion of the predetermined overhead rate (denominator hours - standard hours allowed). Interpretation: The volume variance is favorable when the activity level for a period, at standard, is greater than the denominator activity level. Conversely, if the activity level, at standard, is less than the denominator level of activity, the volume variance is unfavorable. The variance does not measure deviations in spending. It measures deviations in actual activity from the denominator level of activity. Standard Hours Allowed: It is the time that should have been taken to complete the periods output as computed by multiplying the standard quantity or hours by the standard price or rate for each cost element. Denominator level of activity: The level of activity used to compute the predetermined overhead rate. Predetermined overhead rate = Estimated total manufacturing overhead cost/Estimated total units in the base (M.H, DLH). The estimated total unit in the base in the formula for the predetermined overhead rate is called denominator activity. Predetermined overhead rate: Once the denominator level of activity has been chosen, the flexible budget can be used to determine the total amount of overhead cost that should be incurred at that level of activity. Predetermined overhead rate can be computed as overhead from the flexible budget at the denominator level of activity divided by denominator level of activity. How the variable overhead spending variance differ from the materials price variance? The materials price variance consists entirely of differences in price paid from standard. The variable overhead spending variance consists of two elements. One element is like a price variance and results from differences between actual and standard prices for variable overhead inputs. The other element is like a quantity variance and results from differences between the amount of variable overhead inputs that should have been used and the amounts that were actually used. Ordinarily these two elements are not separated. Why is term variable overhead efficiency variance a misnomer? The overhead efficiency variance does not really measure efficiency in the use of overhead. It actually measures efficiency in the use of the base underlying the flexible budget. This base could be direct labor-hours, machine hours, or some other measure of activity. What is the danger in expressing fixed costs on a per unit basis? If fixed costs are expressed on a per unit basis, managers may be misled into thinking that they are really variable. This can lead to faulty predictions concerning cost behavior and to bad decisions and erroneous performance evaluations. Opportunity Cost:

The opportunity cost is the cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action. The difference in return between a chosen investment and one that is necessarily passed up. Say you invest in a stock and it returns a paltry 2% over the year. In placing your money in the stock, you gave up the opportunity of another investment - say, a risk-free government bond yielding 6%. In this situation, your opportunity costs are 4% (6% - 2%). Exercise 11. 5 1. The total overhead cost at the denominator level of activity must be determined before the predetermined overhead rate can be computed. Total fixed overhead cost per year .............. $250,000 Total variable overhead cost ($2 per DLH 40,000 DLHs)............. 80,000 Total overhead cost (250000+80000) at the denominator level of activity = $330,000 Predetermined overhead rate = Overhead at the denominator level of activity/ Denominator level of activity =$330,000/40,000 DLHs =$8.25 per DLH 2. Standard direct labor-hours allowed for the actual output (a).................38,000 DLHs Predetermined overhead rate (b) ............. $8.25 per DLH Overhead applied (a) (b)...................... $313,500 Exercise 11.11 1. Total predetermined overhead rate = Total overhead at denominator level of activity/ denominator level of activity = $480,000/60,000 MHs = $8 per MH Predetermined variable overhead rate = $180000/60000MHs = $3 per MH Predetermined Fixed overhead rate = $300000/60000 MHs = $5 per MH 2. The standard hours per unit of product are: 60,000 hours 40,000 units = 1.5 hours per unit Given this figure, the standard hours allowed for the actual production would be: 42,000 units 1.5 hours per unit = 63,000 standard hours allowed. 3. Variable overhead variance: Variable overhead spending variance = (AH AR) (AH SR)=($185,600) (64,000 hours $3 per hour) = $6,400 F Variable overhead efficiency variance = SR (AH SH)=$3 per hour (64,000 hours 63,000 hours) = $3,000 U The fixed overhead variances would be as follows: Fixed overhead budget variance = Actual fixed overhead cost - Budgeted Fixed Overhead Cost = $302,400 - $300,000 = $2400 U Fixed overhead volume variance = Fixed portion of the predetermined OH Rate x (Denominator hour Standard hours allowed) = $5.00 per MH (60000 MHs 63000MHs) = $15000 F. Problem 11-18 1. Direct materials price and quantity variances: Materials price variance = AQ (AP SP)=64,000 feet ($8.55 per foot $8.45 per foot) = $6,400 U Materials quantity variance = SP (AQ SQ)=$8.45 per foot (64,000 feet 60,000 feet*) = $33,800 U *30,000 units 2 feet per unit = 60,000 feet

2. Direct labor rate and efficiency variances: Labor rate variance = AH (AR SR)=43,500 DLHs ($15.80 per DLH $16.00 per DLH) = $8,700 F Labor efficiency variance = SR (AH SH)=$16.00 per DLH (43,500 DLHs 42,000 DLHs*) = $24,000 U *30,000 units 1.4 DLHs per unit = 42,000 DLHs 3. a) Variable overhead spending and efficiency variances: Variable overhead spending variance = (AH AR) (AH SR)=($108,000) (43,500 DLHs $2.50 per DLH) = $750 F Variable overhead efficiency variance = SR (AH SH) $2.50 per DLH (43,500 DLHs 42,000 DLHs) = $3,750 U b) Fixed overhead variance: Fixed OH Budget variance = Actual fixed -Budgeted fixed overhead cost = $211,800 $210,000 = $1,800 U Fixed OH Volume variance = Fixed portion of predetermined overhead rate x (Denominator hours - Standard hours allowed)=$6.00 per DLH (35,000 DLHs - 42,000 DLHs) = $42,000 F 4. The total of the variances would be: Direct materials variances: Price variance ..................... $ 6,400 U Quantity variance................. 33,800 U Direct labor variances: Rate variance .................. 8,700 F Efficiency variance ................... 24,000 U Variable manufacturing overhead variances: Spending variance .............. 750 F Efficiency variance ................. 3,750 U Fixed manufacturing overhead variances: Budget variance..................... 1,800 U Volume variance .................. 42,000 F Total variance (sum of all of above) = $18,300 U Note that the total of the variances agrees with the $18,300 variance mentioned by the president. It appears that not everyone should be given a bonus for good cost control. The materials quantity variance and the labor efficiency variance are 6.7% and 3.6%, respectively, of the standard cost allowed and thus would warrant investigation. The companys large unfavorable variances (for materials quantity and labor efficiency) do not show up more clearly because they are offset for the most part by the favorable volume variance. This favorable volume variance is a result of the company operating at an activity level that is well above the denominator activity level used to set predetermined overhead rates. (The company operated at an activity level of 42,000 standard hours; the denominator activity level set at the beginning of the year was 35,000 hours.) As a result of the large favorable volume variance, the unfavorable quantity and efficiency variances have been concealed in a small net figure. The large favorable volume variance may have been achieved by building up inventories. Problem 11-21

1. Direct materials, 3 yards at $4.40 per yard ....... $13.20 Direct labor, 1 DLH at $12.00 per DLH .......... 12.00 Variable manufacturing overhead, 1 DLH at $5.00 per DLH*...... 5.00 Fixed manufacturing overhead, 1 DLH at $11.80 per DLH** ...... 11.80 Standard cost per unit (sum of all of above) = $42.00 * $25,000 5,000 DLHs = $5.00 per DLH. ** $59,000 5,000 DLHs = $11.80 per DLH. 2. Materials variances: Materials price variance = AQ (AP SP)=24,000 yards ($4.80 per yard $4.40 per yard) = $9,600 U Materials quantity variance = SP (AQ SQ)=$4.40 per yard (18,500 yards 18,000 yards*) = $2,200 U *6,000 units 3 yards per unit = 18,000 yards Labor variances: Labor rate variance = AH (AR SR) = ,800 DLHs ($13.00 per DLH $12.00 per DLH) = $5,800 U Labor efficiency variance = SR (AH SH) = $12.00 per DLH (5,800 DLHs 6,000 DLHs*) = $2,400 F *6,000 units 1 DLH per unit = 6,000 DLHs 3. Variable overhead variances: Variable overhead spending variance = (AH AR) (AH SR)= ($29,580) (5,800 DLHs $5.00 per DLH) = $580 U Variable overhead efficiency variance = SR (AH SH) $5.00 per DLH (5,800 DLHs 6,000 DLHs) = $1,000 F b) Fixed overhead variance: Fixed OH Budget variance = Actual fixed - Budgeted fixed overhead cost = $60,400 $59,000 = $1,400 U Fixed OH Volume variance = Fixed portion of predetermined overhead rate x (Denominator hours - Standard hours allowed) = $11.80 per DLH (5,000 DLHs - 6,000 DLHs) = $11,800 F. 4. The choice of a denominator activity level affects standard unit costs in that the higher the denominator activity level chosen, the lower standard unit costs will be. The reason is that the fixed portion of overhead costs is spread over more units as the denominator activity rises. The volume variance cannot be controlled by controlling spending. The volume variance simply reflects whether actual activity was greater than or less than the denominator activity. Thus, the volume variance is controllable only through activity.