Managerial Accounting

STANDARD COSTS & VARIANCE ANALYSIS SLIDES PREPARED BY S. M. HUSSAM HAIDER TIRMIZI INSTITUTE ORASOFT

Standard Costs and Varian ! Ana"#sis

Chapter Themes:

earning !b"ectives:
$.

Its all about standards and benchmarks. It is important to measure actual values against goals and standards. Responsibility should be commensurate with controllability.

E%&"ain 'o( standard osts ar! d!)!"o&!d. Ca" +"at! and int!r&r!t )arian !s ,or dir! t -at!ria". Ca" +"at! and int!r&r!t )arian !s ,or dir! t "a/or. Ca" +"at! and int!r&r!t )arian !s ,or -an+,a t+rin1 o)!r'!ad. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

*.

..

0.

2.

Standard Costs
The term standard cost re#ers to the cost that management believes should be incurred to produce a good or service under anticipated conditions. The primary bene#it o# a standard cost system is that it allows #or comparison o# standard versus actual costs. $i##erences are re#erred to as standard cost variances and should be investigated i# signi#icant.

earning !b"ectives:
$.

E%&"ain 'o( standard osts ar! d!)!"o&!d. Ca" +"at! and int!r&r!t )arian !s ,or dir! t -at!ria". Ca" +"at! and int!r&r!t )arian !s ,or dir! t "a/or. Ca" +"at! and int!r&r!t )arian !s ,or -an+,a t+rin1 o)!r'!ad. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

*.

..

0.

2.

Standard Costs and B+d1!ts

At the outset% it is important to understand the subtle di##erences in de#initions o# standard cost and budgeted cost.

Related earning !b"ectives:

$.

E%&"ain 'o( standard osts ar! d!)!"o&!d. Ca" +"at! and int!r&r!t )arian !s ,or dir! t -at!ria". Ca" +"at! and int!r&r!t )arian !s ,or dir! t "a/or. Ca" +"at! and int!r&r!t )arian !s ,or -an+,a t+rin1 o)!r'!ad. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

*.

&tandard cost: the standard cost o# a single unit.

..

0.

'udgeted cost: the cost% at standard% o# the total number o# budgeted units.

2.

D!)!"o&-!nt o, Standard Costs

&tandard costs are developed in a variety o# ways. They are
(.

Related earning !b"ectives:

(.

speci#ied in engineering plans.

)*plain how standard costs are developed. Ca" +"at! and int!r&r!t )arian !s ,or dir! t -at!ria". Ca" +"at! and int!r&r!t )arian !s ,or dir! t "a/or. Ca" +"at! and int!r&r!t )arian !s ,or -an+,a t+rin1 o)!r'!ad. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

*.

..

0.

2.

D!)!"o&-!nt o, Standard Costs

&tandard costs are developed in a variety o# ways. They are
(.

Related earning !b"ectives:

(.

speci#ied by #ormulas or recipes. developed #rom price lists provided by suppliers.

)*plain how standard costs are developed. Ca" +"at! and int!r&r!t )arian !s ,or dir! t -at!ria". Ca" +"at! and int!r&r!t )arian !s ,or dir! t "a/or. Ca" +"at! and int!r&r!t )arian !s ,or -an+,a t+rin1 o)!r'!ad. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

+.

*.

..

0.

2.

D!)!"o&-!nt o, Standard Costs

&tandard costs are developed in a variety o# ways. They are
(.

Related earning !b"ectives:

(.

speci#ied by #ormulas or recipes. developed #rom price lists provided by suppliers. determined time and motion studies conducted by industrial engineers.

)*plain how standard costs are developed. Ca" +"at! and int!r&r!t )arian !s ,or dir! t -at!ria". Ca" +"at! and int!r&r!t )arian !s ,or dir! t "a/or. Ca" +"at! and int!r&r!t )arian !s ,or -an+,a t+rin1 o)!r'!ad. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

+.

*.

..

,.

0.

2.

D!)!"o&-!nt o, Standard Costs

&tandard costs are developed in a variety o# ways. They are
(.

Related earning !b"ectives:

(.

speci#ied by #ormulas or recipes. developed #rom price lists provided by suppliers. determined time and motion studies conducted by industrial engineers. developed #rom analyses o# past data.

)*plain how standard costs are developed. Ca" +"at! and int!r&r!t )arian !s ,or dir! t -at!ria". Ca" +"at! and int!r&r!t )arian !s ,or dir! t "a/or. Ca" +"at! and int!r&r!t )arian !s ,or -an+,a t+rin1 o)!r'!ad. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

+.

*.

..

,.

0.

-.

2.

Id!a" V!rs+s Attaina/"! Standards

In developing standard costs% there are two schools o# thought. Ideal standards: developed under the assumption that no obstacles to the production process will be encountered. They are sometimes re#erred to as per#ection standards. Attainable &tandards: developed under the assumption that there will be occasional problems in the production process such as e.uipment #ailure% labor turnover% and materials de#ects.

Related earning !b"ectives:

(.

)*plain how standard costs are developed. Ca" +"at! and int!r&r!t )arian !s ,or dir! t -at!ria". Ca" +"at! and int!r&r!t )arian !s ,or dir! t "a/or. Ca" +"at! and int!r&r!t )arian !s ,or -an+,a t+rin1 o)!r'!ad. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

*.

..

0.

2.

A 3!n!ra" A&&roa ' to Varian ! Ana"#sis

An analysis o# the di##erence between a standard cost and and actual cost is called variance analysis. The process decomposes the di##erence in two components. /or direct material: materials price and materials .uantity variance. /or direct labor: labor rate 0price1 and labor e##iciency 0.uantity1 variance. /or overhead: overhead volume variance and controllable overhead variance.

Related earning !b"ectives:

$.

E%&"ain 'o( standard osts ar! d!)!"o&!d. Calculate and interpret variances #or direct material. Calculate and interpret variances #or direct labor. Calculate and interpret variances #or manu#acturing overhead. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

+.

,.

-.

2.

Mat!ria" Pri ! Varian !

The material price variance is e*pressed as 0A2 3 &21A4 where: 0A21 5 actual price per unit o# material. 0&21 5 standard price per unit o# direct material. 0A41 5 actual .uantity o# material purchased. I# actual price 6 standard price% then the variance is un#avorable. I# actual price 7 standard price% then the variance is #avorable.

Related earning !b"ectives:

$.

E%&"ain 'o( standard osts ar! d!)!"o&!d. Calculate and interpret variances #or direct material. Ca" +"at! and int!r&r!t )arian !s ,or dir! t "a/or. Ca" +"at! and int!r&r!t )arian !s ,or -an+,a t+rin1 o)!r'!ad. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

+.

..

0.

2.

Mat!ria" 4+antit# Varian !

The material .uantity variance is e*pressed as 0A4 3 &41&2 where: 0A41 5 actual .uantity o# material used. 0&41 5 standard .uantity o# material allowed. 0&21 5 standard price o# material. I# actual .uantity 6 standard .uantity% then the variance is un#avorable. I# actual .uantity 7 standard .uantity% then the variance is #avorable.

Related earning !b"ectives:

$.

E%&"ain 'o( standard osts ar! d!)!"o&!d. Calculate and interpret variances #or direct material. Ca" +"at! and int!r&r!t )arian !s ,or dir! t "a/or. Ca" +"at! and int!r&r!t )arian !s ,or -an+,a t+rin1 o)!r'!ad. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

+.

..

0.

2.

La/or Rat! Varian !

The labor rate 0price1 variance is e*pressed as 0AR 3 &R1A8 where: 0AR1 5 actual wage rate 0price1. 0&R1 5 standard wage rate 0price1. 0A81 5 actual number0.uantity1 o# labor hours. I# actual rate 6 standard rate% then the variance is un#avorable. I# actual rate 7 standard rate% then the variance is #avorable.

Related earning !b"ectives:

$.

E%&"ain 'o( standard osts ar! d!)!"o&!d. Ca" +"at! and int!r&r!t )arian !s ,or dir! t -at!ria". Calculate and interpret variances #or direct labor. Ca" +"at! and int!r&r!t )arian !s ,or -an+,a t+rin1 o)!r'!ad. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

*.

,.

0.

2.

La/or E,,i i!n # Varian !

The labor e##iciency 0.uantity1 variance is e*pressed as 0A8 3 &81&R where: 0A81 5 actual number o# hours worked. 0&81 5 standard number o# hours worked. 0&R1 5 standard labor wage rate. I# actual hours 6 standard hours% then the variance is un#avorable. I# actual hours 7 standard hours% then the variance is #avorable.
,.

Related earning !b"ectives:

$.

E%&"ain 'o( standard osts ar! d!)!"o&!d. Ca" +"at! and int!r&r!t )arian !s ,or dir! t -at!ria". Calculate and interpret variances #or direct labor. Ca" +"at! and int!r&r!t )arian !s ,or -an+,a t+rin1 o)!r'!ad. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

*.

0.

2.

Contro""a/"! O)!r'!ad Varian !

The controllable overhead variance is e*pressed as 0actual overhead 9 #le*ible budget level o# overhead1 #or actual level o# production. It is re#erred to as controllable because managers are e*pected to control costs so they are not substantially di##erent #rom budget. I# actual 6 budget% then the variance is un#avorable. I# actual 7 budget% then the variance is #avorable.
2.

Related earning !b"ectives:

$.

E%&"ain 'o( standard osts ar! d!)!"o&!d. Ca" +"at! and int!r&r!t )arian !s ,or dir! t -at!ria". Ca" +"at! and int!r&r!t )arian !s ,or dir! t "a/or. Calculate and interpret variances #or manu#acturing overhead. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

*.

..

-.

O)!r'!ad Vo"+-! Varian !

The overhead volume variance is e*pressed as 0#le*ible budget level o# overhead #or actual level o# production 9 overhead applied to production using standard overhead rate1. This variance is solely the product o# more or less units being produced than planned in the static budget. Its use#ulness is limited.

Related earning !b"ectives:

$.

E%&"ain 'o( standard osts ar! d!)!"o&!d. Ca" +"at! and int!r&r!t )arian !s ,or dir! t -at!ria". Ca" +"at! and int!r&r!t )arian !s ,or dir! t "a/or. Calculate and interpret variances #or manu#acturing overhead. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

*.

..

-.

2.

In)!sti1ation o, Standard Cost Varian !s

It is important to note that standard cost variances are not a de#initive sign o# good or bad per#ormance. These variances are merely indicators o# potential problems which must be investigated. And there are many plausible e*planations #or them.

Related earning !b"ectives:

$.

E%&"ain 'o( standard osts ar! d!)!"o&!d. Calculate and interpret variances #or direct material. Calculate and interpret variances #or direct labor. Calculate and interpret variances #or manu#acturing overhead. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

+.

,.

-.

2.

Mana1!-!nt /# E% !&tion
'ecause investigation o# standard cost variances is itsel# a costly activity% management must decide which variances to investigate. Most managers practice management by e*ception. :hat is ;e*ceptional<= >sually an absolute dollar amount or a percentage dollar amount.

Related earning !b"ectives:

$.

E%&"ain 'o( standard osts ar! d!)!"o&!d. Ca" +"at! and int!r&r!t )arian !s ,or dir! t -at!ria". Ca" +"at! and int!r&r!t )arian !s ,or dir! t "a/or. Ca" +"at! and int!r&r!t )arian !s ,or -an+,a t+rin1 o)!r'!ad. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

*.

..

0.

2.

5Fa)ora/"!6 Varian !s Ma# B! Un,a)ora/"!

The #act that a variance is ;#avorable= does not mean that it should not be investigated. Raw materials are good e*amples o# this phenomenon% especially considering the competitive pricing environment #or most commodities. &uppose in#erior% low9priced materials are ordered. !ne the one hand% a #avorable price variance will arise. !n the other hand% most likely there will be substantially more scrap and rework% and thus a higher .uantity variance.

Related earning !b"ectives:

$.

E%&"ain 'o( standard osts ar! d!)!"o&!d. Ca" +"at! and int!r&r!t )arian !s ,or dir! t -at!ria". Ca" +"at! and int!r&r!t )arian !s ,or dir! t "a/or. Ca" +"at! and int!r&r!t )arian !s ,or -an+,a t+rin1 o)!r'!ad. Dis +ss 'o( t'! -ana1!-!nt /# !% !&tion a&&roa ' is a&&"i!d to in)!sti1ation o, standard ost )arian !s.

*.

..

0.

2.

R!s&onsi/i"it# A o+ntin1 and Varian !s

As noted previously% managers should be held responsible only #or costs they can control. This is true in the area o# variance analysis. /or e*ample% a purchasing agent may be held responsible #or direct material price variances% but certainly not direct material .uantity 0usage1 variances.
Related earning !b"ectives:
(.

)*plain how standard costs are developed. Calculate and interpret variances #or direct material. Calculate and interpret variances #or direct labor. Calculate and interpret variances #or manu#acturing overhead. $iscuss how the management by e*ception approach is applied to investigation o# standard cost variances.

+.

,.

-.

?.

A&&!ndi% A7 R! ordin1 Standard Costs in A o+nts

In a standard costing system% the costs added to the Raw Materials Inventory% :ork in 2rocess Inventory% /inished @oods Inventory% and Cost o# @oods &old accounts are all recorded at standard rather than actual cost. Aariances are also calculated and recorded #or managements use in per#ormance evaluation.

Related earning !b"ectives:

(.

Record standard costs in the account o# a manu#acturing #irm.

R! ordin1 Mat!ria" Costs

2urchase o# raw materials inventory: Accountdr. cr. Raw Material Inventory 0std.1 * Material 2rice Aariance * *

Accounts 2ayable 0actual1

0This is an un#avorable price variance1 >sage o# raw materials inventory: Accountdr. cr. :ork in 2rocess Inventory Material 4uantity Aariance Raw Material Inventory * * *

Related earning !b"ectives:

Record standard costs in the account o# a manu#acturing #irm.

0This is an un#avorable .uantity variance1

R! ordin1 La/or Cost

Account dr. cr.

:ork in 2rocess Inventory 0std.1 * abor Rate Aariance abor )##iciency Aariance * *

&alaries 2ayable 0actual1 * 0Bote: both the labor rate variance and e##iciency variance are un#avorable1

Related earning !b"ectives:

Record standard costs in the account o# a manu#acturing #irm.

R! ordin1 Man+,a t+rin1 O)!r'!ad

Recording manu#acturing overhead in a standard costing system is a three9step process:

(.

Actual overhead is recorded in the manu#acturing overhead account. !verhead is applied to :ork in 2rocess Inventory at the standard cost. The di##erence between actual overhead and overhead applied at standard is closed and overhead variances are identi#ied. More

+.

,.

Related earning !b"ectives:

Record standard costs in the account o# a manu#acturing #irm.

R! ordin1 Man+,a t+rin1 O)!r'!ad 8St!& $9

To record actual overhead cost:

Account

dr. cr. * *

Manu#acturing !verhead CAarious Accounts

Related earning !b"ectives:

CAarious accounts include indirect wages payable% utilities payable and accumulated depreciation.
Record standard costs in the account o# a manu#acturing #irm.

R! ordin1 Man+,a t+rin1 O)!r'!ad 8St!& *9

To apply overhead cost to work in process inventory at cost:

Account

dr. cr. * *

:ork in 2rocess Inventory Manu#acturing !verhead

Related earning !b"ectives:

Record standard costs in the account o# a manu#acturing #irm.

R! ordin1 Man+,a t+rin1 O)!r'!ad 8St!& .9

To close out manu#acturing overhead cost to work in process inventory at cost:

Account

dr. cr. *

Manu#acturing !verhead !verhead Aolume Aariance *

Related earning !b"ectives:

Record standard costs in the account o# a manu#acturing #irm.

Controllable !verhead Aariance *

R! ordin1 Finis'!d 3oods

To record completed units sent to #inished goods:

Account

dr. cr. *

/inished @oods Inventory :ork in 2rocess Inventory *

Related earning !b"ectives:

Record standard costs in the account o# a manu#acturing #irm.

R! ordin1 Cost o, 3oods So"d

To apply overhead cost to work in process inventory at cost:

Account

dr. cr. *

Cost o# @oods &old /inished @oods Inventory

Related earning !b"ectives:

Record standard costs in the account o# a manu#acturing #irm.

C"osin1 Varian ! A

o+nts

At the end o# the accounting period% the temporary variance accounts must be closed. As a practical matter this is usually accomplished by debiting or crediting the variances to cost o# goods sold. Account dr. cr. * * *

Cost o# @oods &old

!verhead Aolume Aariance

Controllable !verhead Aariance Material 2rice Aariance *

Related earning !b"ectives:

Record standard costs in the account o# a manu#acturing #irm.

Material 4uantity Aariance abor Rate Aariance abor )##iciency Aariance *