Chapter 7 Standard Costing and Variance Analysis Cost

Learning Objectives n n n Why are standard cost systems used? How are material,

Standard Cost Systems n n Manufacturing, service and not-for-profit organizations Record standard and actual

Use of Standard Cost Systems n n n Motivating Planning Controlling – variance analysis

Setting Standards and Trends n Setting Standards q q Appropriateness Attainability n n n

Standards n Standard costs are budgeted costs to q q n Manufacture a single

Manufacturing Objective Minimize unit cost while achieving certain quality specifications. Input Resources Output Quality

Material Standards n Materials used q q Types Quality Quantity Price n From q

© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or

Labor Standards n Labor used q Types n q q n From q Production,

Overhead Standards Variable and fixed manufacturing overhead n Estimated level of activity n Estimated

Standard Cost Card For one unit of output (a bike) Standard Direct Material Components

Variance Analysis § Variance is the difference between an actual cost and a standard

Total Variance Total actual cost incurred minus total standard cost applied to output produced

Total Variance AP x AQ Inputs SP x SQ Total Variance Outputs AP =

Price Variance AP x AQ SP x SQ Price/Rate Variance Total Variance What was

Usage Variance AP x AQ What was used SP x AQ SP x SQ

Material Price Variance (MPV) AP x AQ SP x SQ MPV Total Variance What

MPV Calculations n Calculate MPV at q Point of purchase or q When materials

Material Quantity Variance (MQV) AP x AQ SP x SQ MQV What was used

Labor Rate Variance (LRV) AP x AQ SP x SQ LRV Total Variance What

Labor Efficiency Variance (LEV) AP x AQ SP x SQ LEV What was used

Overhead Variances Variable Overhead Fixed Overhead Actual variable overhead is total of various ledger

Variable Overhead Variances Actual VOH Actual For actual hours used Budgeted VOH Applied VOH

VOH Spending Variance n Caused by price differences q n Managers have little control

Fixed Overhead Variances Actual FOH Budgeted FOH Applied FOH SP x SQ Constant Amount

FOH Spending and Volume Variance n FOH Spending Variance q q q Calculate variance

Alternative Overhead Variance Approaches One variance n Two variance n Three variance n Four

One Variance Approach Standard Cost of OH SP x SQ Actual OH Total OH

Two Variance Approach Actual Budgeted OH Standard OH based on SQ Cost of OH

Three Variance Approach Actual OH Budgeted OH based on Actual Inputs OH Spending Variance

Standard Cost Journal Entries n n Variances recorded in accounting system Favorable variances q

Purchase of Materials (Point of Purchase Method) At Standard Cost Materials SP x AQ

Use of Materials At Standard Cost WIP SP x SQ allowed Materials Quantity Variance

Record Labor LRV At Standard Cost WIP U F LEV U F Wages Pay

Apply Overhead WIP SP x SQ Allowed VOH SP x SQ Allowed FOH SP

Year-End Treatment for VOH Efficiency Variance VOH Spending Variance VOH Actual Applied -------- Debit—Unfavorable

Year-End Treatment for FOH Spending Variance Volume Variance FOH Actual Applied ------- Debit—Unfavorable Credit—Favorable

Year-End Treatment of Variances Immaterial—Adjust Cost of Goods Sold Material—Prorate variances to: n Material

Conversion Costs n n Combine direct labor and manufacturing overhead Variances q q q

Material Price, Mix, and Yield Variances AM x AQ x AP Material Price Variance

Labor Rate, Mix, and Yield Variances AM x AH x AR Labor Rate Variance

Questions n n n Why are standard cost systems used? How are standards set

Potential Ethical Issues n n n Setting high standards to create favorable variances Ignoring

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Chapter 7: Standard Costing and Variance Analysis Cost Accounting: Foundations and Evolutions, 9 e Kinney ● Raiborn © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Learning Objectives n n n Why are standard cost systems used? How are material, labor, and overhead standards set? How are material, labor, and overhead variances calculated and recorded? How have the setting and use of standards changed over time? How does the use of a single conversion element (rather than the traditional labor and overhead elements) affect standard costing? (Appendix) How are variances affected by multiple material and labor categories? © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Standard Cost Systems n n Manufacturing, service and not-for-profit organizations Record standard and actual costs in the accounting records Provides an essential element of cost control: having norms against which actual operations can be compared Clerical efficiency © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Use of Standard Cost Systems n n n Motivating Planning Controlling – variance analysis Decision Making Performance Evaluation © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Setting Standards and Trends n Setting Standards q q Appropriateness Attainability n n n Expected standards Practical standards Ideal standards n Trends in Standards q Ideal Standards and Theoretical Capacity q Adjusting standards q Price variance on purchase versus usage q Decline in direct labor content © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Standards n Standard costs are budgeted costs to q q n Manufacture a single unit of product or Perform a single service To develop standards, identify q q Material and labor types, quantities, and prices Overhead types and behavior © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Manufacturing Objective Minimize unit cost while achieving certain quality specifications. Input Resources Output Quality © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Material Standards n Materials used q q Types Quality Quantity Price n From q q Product specifications, observation, inquiry Bill of materials § Balance cost, quality, and projected sales price Standard Material = Cost Unit Purchase Price * quantity © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Labor Standards n Labor used q Types n q q n From q Production, setup, cleanup, and rework Quantity Cost n Include wages, payroll taxes, and fringe benefits Standard Labor = Cost q Industrial engineering studies including methods-time measurement (MTM), time and motion studies, historical data Operations flow document Hours * Wage Rate © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Overhead Standards Variable and fixed manufacturing overhead n Estimated level of activity n Estimated costs n Predetermined factory overhead application rates n © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Standard Cost Card For one unit of output (a bike) Standard Direct Material Components Standard Direct Labor Components Manufacturing Overhead Variable Overhead Fixed Overhead © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Variance Analysis § Variance is the difference between an actual cost and a standard cost. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Total Variance Total actual cost incurred minus total standard cost applied to output produced Actual cost of actual production input Standard cost of actual production output Total Variance* *Favorable or unfavorable © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Total Variance AP x AQ Inputs SP x SQ Total Variance Outputs AP = actual cost/price per unit of materials or hours of labor AQ = actual quantity of materials or hours of labor SP = standard cost/price per unit of materials or hours of labor SQ = standard quantity of materials or hours of labor © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Price Variance AP x AQ SP x SQ Price/Rate Variance Total Variance What was paid (AP – SP) x AQ* What should have been paid *Favorable or unfavorable © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Usage Variance AP x AQ What was used SP x AQ SP x SQ Usage Variance Total Variance (AQ – SQ) x *Favorable or unfavorable SP* What should have been used for the level of output © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Material Price Variance (MPV) AP x AQ SP x SQ MPV Total Variance What was paid (AP – SP) x AQ* What should have been paid *Favorable or unfavorable © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

MPV Calculations n Calculate MPV at q Point of purchase or q When materials used © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Material Quantity Variance (MQV) AP x AQ SP x SQ MQV What was used Total Variance (AQ – SQ) x *Favorable or unfavorable SP* What should have been used for level of output © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Labor Rate Variance (LRV) AP x AQ SP x SQ LRV Total Variance What was paid (AP – SP) x AQ* What should have been paid *Favorable or unfavorable © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Labor Efficiency Variance (LEV) AP x AQ SP x SQ LEV What was used Total Variance (AQ – SQ) x *Favorable or unfavorable SP* What should have been used for level of output © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Overhead Variances Variable Overhead Fixed Overhead Actual variable overhead is total of various ledger accounts Actual fixed overhead is total of various ledger accounts SP = Predetermined variable overhead rate SP = Predetermined fixed overhead rate © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Variable Overhead Variances Actual VOH Actual For actual hours used Budgeted VOH Applied VOH SP x AQ SP x SQ VOH Spending Variance VOH Efficiency Variance Total VOH Variance What should have been used for level of output © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

VOH Spending Variance n Caused by price differences q n Managers have little control over prices Caused by shrinkage or waste q Managers should be held accountable © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Fixed Overhead Variances Actual FOH Budgeted FOH Applied FOH SP x SQ Constant Amount FOH Spending Variance FOH Volume Variance Total FOH Variance What should have been used for level of output © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

FOH Spending and Volume Variance n FOH Spending Variance q q q Calculate variance for each component Caused by price differences May reflect mismanagement of resources n FOH Volume Variance q q q Measures capacity utilization Caused by producing at a level that differs from the capacity level used to compute the predetermined overhead rate Also called the noncontrollable variance © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Alternative Overhead Variance Approaches One variance n Two variance n Three variance n Four variance n © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

One Variance Approach Standard Cost of OH SP x SQ Actual OH Total OH Variance Applied Overhead © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Two Variance Approach Actual Budgeted OH Standard OH based on SQ Cost of OH SP x SQ Budget Variance Volume Variance Total OH Variance Applied Overhead © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Three Variance Approach Actual OH Budgeted OH based on Actual Inputs OH Spending Variance based on Standard Output OH Efficiency Variance Total OH Variance Standard OH SP x SQ Volume Variance Applied Overhead © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Standard Cost Journal Entries n n Variances recorded in accounting system Favorable variances q q n Unfavorable variances q q n Credits Represent savings in production costs Debits Represent excess production costs Inventories are recorded at standard cost during the period © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Purchase of Materials (Point of Purchase Method) At Standard Cost Materials SP x AQ purchased Materials Price Variance U Accts Pay F AP x AQ purchased Debit—Unfavorable Credit—Favorable © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Use of Materials At Standard Cost WIP SP x SQ allowed Materials Quantity Variance U Materials F SP x AQ used Debit—Unfavorable Credit—Favorable © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Record Labor LRV At Standard Cost WIP U F LEV U F Wages Pay AP x AQ SP x SQ allowed Debit—Unfavorable Credit—Favorable © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Apply Overhead WIP SP x SQ Allowed VOH SP x SQ Allowed FOH SP x SQ Allowed © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Year-End Treatment for VOH Efficiency Variance VOH Spending Variance VOH Actual Applied -------- Debit—Unfavorable Credit—Favorable Enter a debit or credit to bring balance to zero © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Year-End Treatment for FOH Spending Variance Volume Variance FOH Actual Applied ------- Debit—Unfavorable Credit—Favorable Enter a debit or credit to bring balance to zero © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Year-End Treatment of Variances Immaterial—Adjust Cost of Goods Sold Material—Prorate variances to: n Material Price Variances q q Raw Materials WIP Finished Goods Cost of Goods Sold n All other variances q q q WIP Finished Goods Cost of Goods Sold © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Conversion Costs n n Combine direct labor and manufacturing overhead Variances q q q Spending variance for overhead Efficiency variances for machinery and production costs Volume variances for production © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Material Price, Mix, and Yield Variances AM x AQ x AP Material Price Variance AM—Actual Mix SM—Standard Mix AM x AQ x SP SM x AQ x SP Material Mix Variance SM x SQ x SP Material Yield Variance What should have been used for level of output? © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Labor Rate, Mix, and Yield Variances AM x AH x AR Labor Rate Variance M—Mix H—Hours R—Rate AM x AH x SR SM x SH x SR SM x AH x SR Labor Mix Variance Labor Yield Variance What should have been used for level of output? © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Questions n n n Why are standard cost systems used? How are standards set for material, labor, and overhead? How is variance analysis used for control and performance evaluation? © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Potential Ethical Issues n n n Setting high standards to create favorable variances Ignoring effects of one production area on another Setting overhead rates too low based on high production levels to distort inventory cost and operating income Producing inventory only to create a favorable volume variance Not updating standards so that favorable variances are created Using low quality materials or labor to create favorable variances and low quality products © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.