1

Standard Costing and Variance Analysis Lecture

This chapter covers standard costing and variances.

LEARNING OBJECTIVES
At the end of this lecture, students should be able to: 1. 2. 3. 4. 5. Explain how unit standards are set and why standard cost systems are adopted. Explain the purpose of a standard cost sheet. Describe the basic concepts underlying variance analysis and explain when variances should be investigated. Compute the materials and labor variances and explain how they are used for control. Compute the variable overhead variances and explain their meanings.

KEY TOPICS
The following major topics are covered in this chapter (related learning objectives are listed for each topic). 1. 2. 3. 4. 5. 1. A. Unit standards(Learning Objective 1) Standard product costs(Learning Objective 2) Variance analysis:General description(Learning Objective 3) Variance analysis:Materials and labor(Learning Objective 4) Variance analysis:Overhead costs(Learning Objective 5 UNIT STANDARDS Introduction

Cost control.The opening scenario illustrates that many prosperous companies tend to ignore the need for cost control. As conditions become more competitive and profits are being squeezed, it suddenly becomes more important to be cost conscious. In reality, even prosperous firms should be cost conscious. By exerting control over costs in prosperous times, the ability to weather more demanding times is improved. Comparing actual amounts with budgeted amounts is one approach to control. A standard cost is the expected or budgeted cost of materials, labor, and manufacturing overhead required to produce one unit of product. The unit standard cost is calculated as follows: Price standard Quantity standard A price standard is the price that should be paid per unit of input (such as pound of material). A quantity standard is the quantity of input allowed per unit of output (for example, pounds of material allowed per one unit of product). A standard cost sheet calculates the total standard cost for one unit of product. It lists the standard costs for one unit of product for the following:

Materials(Price standard Quantity standard) Labor(Price standard Quantity standard) Variable manufacturing overhead(Price standard Quantity standard) Fixed manufacturing overhead(Price standard Quantity standard)

B.

Why Standard Cost Systems Are Adopted

Two reasons for adopting a standard cost system are:

To improve planning and control.A standard cost system compares actual amounts with stan dard amounts to determine variances from the standard. The use of a standard cost system for operational control in an advanced manufacturing environment can produce dysfunctional behavior. However, standards in the advanced manufacturing environment are still useful for planning, such as developing bids. To facilitate product costing.Standard costing uses standard costs for direct materials, direct labor, and overhead. Standard cost systems provide readily available unit cost information that can be used for pricing decisions.

Costs under the three product cost assignment approaches are summarized below:
PRODUCT COSTING SYSTEM MANUFACTURING COSTS Direct Materials Direct Labor Overhead

Actual costing system Normal costing system Standard costing system

Actual Actual Standard

Actual Actual Standard

Actual Budgeted Standard

2.

STANDARD PRODUCT COSTS

The standard cost sheet provides the unit quantity and price standards and the standard cost per unit. The standard cost sheet for one unit of product might appear as follows:

STANDARD COST SHEET Production Costs for One Unit of Product

Direct materials (Standard quantity of materials Standard price for materials) Direct labor (Standard direct labor hours Standard direct labor rate) Variable manufacturing overhead (Standard direct labor hours Standard variable overhead rate) Fixed manufacturing overhead (Standard direct labor hours Standard fixed overhead rate) Total standard cost per unit of product

The standard cost for direct materials is calculated as follows: Standard cost for direct materials = Standard quantity of materials Standard price for the materials Standard quantity of materials allowed (SQ) is calculated: SQ = Unit quantity standard Actual output The standard direct labor cost for a unit of product would be calculated as follows: Standard direct labor cost = Standard quantity of direct labor Standard rate per direct labor hour Standard hours allowed (SH) is calculated: SH = Unit labor standard Actual output

3.

VARIANCE ANALYSIS:GENERAL DESCRIPTION

The total budget variance is the difference between actual cost of inputs and the standard (or planned) cost of inputs. There are two variances for variable production costs: 1. 2. price or rate variances the difference between actual costs of inputs and what the inputs should have cost (standard prices). usage or efficiency variances the difference between the actual quantity used and the standard quantity allowed for units produced.

The general model for calculating variable cost variances appears below:
Actual quantity of input at actual price (AP AQ ) (AP SP)AQ Price variance Actual quantity of input at standard price (SP AQ ) (AQ SQ )SP Usage or efficiency variance Standard quantity of input at standard price (SP SQ)

Total variance = (AP AQ) (SP SQ )

If the actual price or quantity is less than the standard, the variance is considered favorable. If the actual price or quantity exceeds the standard, the variance is considered unfavorable.

4.
A.

VARIANCE ANALYSIS:MATERIALS AND LABOR

Direct Materials Variances

Direct Materials Price Variance The materials price variance (MPV ) for materials is calculated as follows:
Actual quantity purchased at actual price (AP AQ ) (AP SP)AQ Direct materials price variance Actual quantity purchased at standard price (SP AQ )

The materials price variance can be computed at one of two points: 1. 2. When the raw materials are issued for use in production When the raw materials are purchased

Variances should be calculated at the earliest point possible so management can take any necessary corrective action. Thus, the price variance for materials should be calculated at the time of purchase. Responsibility for the materials price variance is usually assigned to the purchasing agent. Variance analysis involves the following process:

Decide whether the variance is significant. If insignificant, no further investigation is needed. If significant, investigate the cause of the variance and take corrective action if necessary.

Direct Materials Usage Variance The materials usage variance (MUV ) is calculated as follows:
Actual quantity used at standard price (SP AQ ) (AQ SQ )SP Direct materials usage variance Standard quantity allowed at standard price (SP SQ)

The production manager is usually responsible for materials usage because the production manager can minimize scrap, waste, and rework in order to meet the standard.

The materials usage variance is calculated at the time materials are issued or used in the manufacturing process. B. Direct Labor Variances

Labor Rate Variance The labor rate variance (LRV ) is calculated as follows:
Actual labor hours at actual rate (AR AH) (AR SR)AH Direct labor rate variance Actual labor hours at standard rate (SR AH)

When labor rate variances occur, it is usually due to:

using the average wage rate as the standard rate, or using more skilled and higher paid laborers for less skilled tasks.

Responsibility for the labor rate variance is often assigned to the individual, such as the production manager, who decides how labor will be used. The labor efficiency variance (LEV ) is calculated as follows:
Actual labor hours at standard rate (AH SR) (AH SH)SR Direct labor efficiency variance Standard labor hours allowed at standard rate (SH SR)

Usually production managers are responsible for the direct labor efficiency variance; however, once the cause of the variance is discovered, responsibility may be assigned elsewhere. The total variance for direct labor would be the sum of the rate variance and the efficiency variance. The total variance can also be calculated as follows: Total direct labor variance = (Actual quantity Actual price) (Standard quantity Standard price) A. Variable Overhead Variances

Variable Overhead Spending Variance The variable overhead spending variance is calculated as follows:
Actual variable overhead rate Actual hours Standard variable overhead rate Actual hours (AVOR AH) (SVOR AH) (AVOR SVOR)AH Variable overhead spending variance

Price changes of variable overhead items are essentially beyond the control of supervisors; therefore, the variable overhead spending variance is usually assigned to the production departments. Variable Overhead Efficiency Variance The variable overhead efficiency variance results from the efficient or inefficient use of the base used to apply variable manufacturing overhead. For example, if variable manufacturing overhead is applied using direct labor hours as the base and there is an unfavorable labor efficiency variance, there will also be an unfavorable variable overhead efficiency variance.

The variable overhead efficiency variance is calculated as follows:

Standard variable overhead rate Actual hours (AH SVOR) (AH SH)SVOR Variable overhead efficiency variance Standard variable overhead rate Standard hours (SH SVOR)

If variable overhead costs change in proportion to changes in the base, such as direct labor hours, then responsibility for the variable overhead efficiency variance should be assigned to the production manager because the production manager has responsibility for the use of direct labor. Total Variable Overhead Variance The total variable overhead variance is calculated as follows:
Actual variable overhead Variable overhead rate Actual hours (SVOR AH) Applied variable overhead Variable overhead rate Standard hours (SVOR SH)

Variable overhead spending variance

Variable overhead efficiency variance

Total variable overhead variance