STANDARD COSTING AND VARIANCE ANALYSIS Acc 2203 workshop

STANDARD COSTING AND VARIANCE ANALYSIS Acc 2203 workshop Sindhu bala

Variances Managers use variance analysis to compare actual results with expected results and to investigate why actual results differ from expectations for performance evaluation purposes. A firm sets standards for production costs to articulate its expectations with respect to its operational performance and financial results. Setting production cost standards requires a collaborative effort by accountants, engineers, personnel administrators, and production managers Direct Material Standards: Direct Labor Standards: Rate standards – Use labor contracts, wage surveys Time standards – Use time and motion studies Variable Overhead Standards: Price standards – Final cost of materials after delivery and net of discounts Quantity standards – Use product design specifications Rate standards – Variable portion of the predetermined overhead rate Activity standards – Expected usage of the allocation base Fixed Overhead Standards: Fixed portion of predetermined overhead rate

Example – Chocolate Co. Standard Cost For One Chocolate In 2010 Standard quantity of input to make one chocolate Standard price of input 1 $7 $7 Direct Labor . 5 DLH $10/DLH $5 Variable overhead . 5 DLH $6/DLH $3 Fixed overhead . 5 DLH $10/DLH $5 Direct Materials Total standard cost per unit Standard cost of input per chocolate $20

Variance Analysis Cost variance – the difference between actual cost and expected/budgeted/standard cost Favorable cost variance – occurs when actual cost is lower than expected cost for a given level of output Unfavorable cost variance – occurs when actual cost is greater than expected cost for a given level of output Do favorable cost variances always signal that the company has performed well in keeping its costs down?

A General Framework For Variance Analysis Actual Quantity (AQ) X Actual Price (AP) Actual Quantity (AQ) x Standard Price (SP) Standard Quantity (SQ) x Standard Price (SP) Price Variance Quantity Variance AQ (AP-SP) SP (AQ-SQ) IMPORTANT NOTE: SQ is the standard quantity allowed for the ACTUAL units produced

A General Framework For Variance Analysis Actual Quantity (AQ) X Actual Price (AP) Actual Quantity (AQ) x Standard Price (SP) Standard Quantity (SQ) x Standard Price (SP) Price Variance Quantity Variance AQ (AP-SP) SP (AQ-SQ) Total Variance IMPORTANT NOTE: SQ is the standard quantity allowed for the ACTUAL units produced

General Framework for Variance Analysis

Direct Material Variances – Example 3 The Cane Company produced 500 industrial plastic containers. The standard cost of making each container is 3 lb. of plastic at $1. 5/lb. (same as above). SQ x SP Standard quantity of plastic Standard price of plastic allowed for producing 500 containers 3 lb. /container x 500 containers = 1, 500 lb. x $1. 5/lb =$2, 250 To make 500 containers the company purchased and used 2, 000 lb. of plastic and incurred $4, 000 for the cost of plastic. Total Variance: The cause of the variance: Was the plastic quantity different from the

Formulas for computing DM variances Materials price variance = AQ x AP – SP x AQ = AQ (AP – SP) Materials quantity variance = AQ x SP – SP x SQ = SP (AQ – SQ) Compute the materials price variance and materials quantity variance for the Cane Company using the last example DM price variance = DM quantity variance = In the last example, the Cane Company purchased expensive materials that cost the company $1, 000 more than expected; the materials were not used as efficiently as expected costing the company an additional $750. How can the company act on this information?

Direct Material Variances When Quantity Of Materials Purchased Is Not Equal To The Quantity Of Materials Used In Production When quantity of materials purchased is not equal to the quantity of materials used in production: -Compute materials price variance using quantity of materials purchased -Compute materials quantity variance using quantity of materials used in production Example: Mert Company uses a standard cost system. Information for raw materials for Product A for the month of October follows: Standard price per pound of raw materials: $1. 60 Actual purchase price per pound of raw materials: $1. 55 Actual quantity of raw materials purchased: 2, 000 pounds Actual quantity of raw materials used: 1, 900 pounds Standard quantity allowed for actual production: 1, 800 pounds Compute Mert’s materials price variance and materials quantity variance

Direct Material Variances When Quantity Of Materials Purchased Is Not Equal To The Quantity Of Materials Used In Production AQx. AP AQx. SP SQx. SP Explain why the quantity of materials purchased is more appropriate in calculating materials price variance than the quantity of materials used in production

Concept Check 1. The standard and actual prices per pound of raw material are $4. 00 and $4. 50, respectively. A total of 10, 500 pounds of raw material was purchased and then used to produce 5, 000 units. The quantity standard allows two pounds of the raw material per unit produced. What was the materials quantity variance? a. $5, 000 unfavorable b. $5, 000 favorable c. $2, 000 favorable d. $2, 000 unfavorable 2. Referring to the facts in question 1 above, what was the material price variance? a. $5, 250 favorable b. $5, 250 unfavorable c. $5, 000 unfavorable d. $5, 000 favorable

Concept Check 3. The actual direct labor wage rate is $8. 50 and 4, 500 direct labor hours were actually worked during the month. The standard direct labor wage rate is $8. 00 and the standard quantity of hours allowed for the actual level of output was 5, 000 direct labor hours. What was the direct labor efficiency variance? a. $4, 000 favorable b. $4, 000 unfavorable c. $4, 500 unfavorable d. $4, 500 favorable 4. Referring to the facts in question 3 above, what is the variable overhead efficiency variance if the standard variable overhead per direct labor hour is $5. 00? a. $5, 000 favorable b. $5, 000 unfavorable c. $2, 500 unfavorable d. $2, 500 favorable

Variable Overhead Variances Actual Variable Overhead Incurred Flexible Budget for Variable Overhead at Actual Hours AH × AR AH × SR Rate Variance Flexible Budget for Variable Overhead at Standard Hours SH × SR Efficiency Variance Rate variance = AH(AR - SR) Efficiency variance = SR(AH - SH)

Variable Overhead Variances – Example Cola. Co’s actual production for the period required 3, 200 standard machine hours. Actual variable overhead incurred for the period was $6, 740. Actual machine hours worked were 3, 300. The standard variable overhead cost per machine hour is $2. 00. Compute the variable overhead rate variance and variable overhead efficiency variance. .

Quick Check Yoder Enterprises’ actual production for the period required 2, 100 standard direct labor hours. Actual variable overhead for the period was $10, 950. Actual direct labor hours worked were 2, 050. The predetermined variable overhead rate is $5 per direct labor hour. What was the variable overhead rate variance? a. $450 U b. $450 F c. $700 F d. $700 U

Quick Check Yoder Enterprises’ actual production for the period required 2, 100 standard direct labor hours. Actual variable overhead for the period was $10, 950. Actual direct labor hours worked were 2, 050. The predetermined variable overhead rate is $5 per direct labor hour. What was the VOH efficiency variance? a. $450 U b. $450 F c. $250 F d. $250 U

Overhead Rates and Overhead Analysis Recall that overhead costs are assigned to products and services using a predetermined overhead rate (POHR): Assigned Overhead = POHR × Standard Activity POHR = Overhead from the flexible budget for the denominator level of activity Denominator level of activity

Overhead Rates and Overhead Analysis The predetermined overhead rate can also be broken down into fixed and variable components: The variable component is useful for preparing and analyzing variable overhead variances. The fixed component is useful for preparing and analyzing fixed overhead variances.

Normal versus Standard Cost Systems In a normal cost system, overhead is applied to work in process based on the actual number of hours worked in the period. In a standard cost system, overhead is applied to work in process based on the standard hours allowed for the output of the period.

Fixed Overhead Variances Actual Fixed Overhead Incurred Budget Variance Fixed Overhead Budget DH × FR Fixed Overhead Applied SH × FR Volume Variance FR = Standard Fixed Overhead Rate SH = Standard Hours Allowed DH = Denominator Hours

Overhead Rates and Overhead Analysis – Example Cola. Co prepared this flexible budget for overhead: Machine Hours 3, 000 4, 000 Total Variable Overhead $ Variable Overhead Rate 6, 000 ? 8, 000 ? Total Fixed Overhead $ Fixed Overhead Rate 9, 000 ? Let’s calculate overhead rates. Cola. Co applies overhead based on machine-hour activity.

Fixed Overhead Variances – Example Cola. Co’s actual production required 3, 200 standard machine hours. Actual fixed overhead was $8, 450. The predetermined overhead rate is based on 3, 000 machine hours. What is the budget variance? The volume variance?

Volume Variance – A Closer Look Volume Variance Results when standard hours allowed for actual output differs from the denominator activity. Unfavorable when standard hours < denominator hours Favorable when standard hours > denominator hours

Volume Variance – A Closer Look Volume Variance Does not measure overor under spending Results when standard hours Itallowed resultsforfrom fixed actualtreating output differs from the denominator activity. overhead as if it were a variable cost. Unfavorable when standard hours < denominator hours Favorable when standard hours > denominator hours

Quick Check Yoder Enterprises’ actual production for the period required 2, 100 standard direct labor hours. Actual fixed overhead for the period was $14, 800. The budgeted fixed overhead was $14, 450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the budget variance? a. $350 U b. $350 F c. $100 F d. $100 U