Standard Costing: A Managerial Control Tool CHAPTER

After studying this chapter, you should be able to: Objectives 1. Tell how unit standards are set and why standard costing systems are adapted. 2. State the purpose of a standard cost sheet. 3. Describe the basic concepts underlying variance analysis, and explain when variances should be investigated. 4. Compute the material and labor variances, and explain how they are used for control. After studying this chapter, you should be able to: Continued

Objectives 5. Calculate the variable and fixed overhead variances, and give their definitions. 6. Appendix: Prepare journal entries for materials and labor variances, and show how to account for overhead variances.

Cost control often means the difference between success and failure.

Why Standard Cost Systems Are Adopted Standard costing systems enhance planning and control and improve performance measurement. Standard costing systems facilitate product costing.

Cost Assignment Approaches Manufacturing Costs Direct Direct Materials Labor Overhead Actual costing system Actual Actual Actual Normal costing system Actual Actual Budgeted Standard costing system Standard Standard Standard

Standard Cost Sheet for Corn Chips Standard Standard Standard Price Usage Cost Subtotal Description Direct materials: Yellow corn $0.006 18 oz. $0.108 Cooking oil 0.031 2 oz. 0.062 Salt 0.005 1 oz. 0.005 Lime 0.400 0.01 oz. 0.004 Bags 0.044 1 bag. 0.044 Total direct materials $0.223

Standard Cost Sheet for Corn Chips Standard Standard Standard Price Usage Cost Subtotal Description Direct materials $0.223 Direct labor: Inspectors $7.000 0.0070 hr. $0.049 Machine operators 10.000 0.0008 hr. 0.008 Total direct labor 0.057 Overhead: Variable overhead 3.850 0.078 hr. $0.030 Fixed overhead 32.050 0.0078 hr. 0.250 Total overhead 0.280 Total standard unit cost $0.560

The standard quantity of yellow corn meal per package is 18 ounces. During the first week of March, 100,000 packages of corn chips are produced. The standard quantity of yellow corn meal per package is 18 ounces.

Standard Quantity of Materials Allowed Standard Hours Allowed SQ = Unit quantity standard x Actual output = 18 x 100,000 = 1,800,000 ounces Standard Hours Allowed SH = Unit labor standard x Actual output = 0.0008 x 100,000 = 80 direct labor hours

Total variance = Price variance + Usage variance = (AP – SP)AQ + (AQ – SQ)SP = [(AP x AQ) – (SP x AQ)] + [(SP x AQ) – (SP x SQ)] = (AP x AQ) – (SP x AQ)] + (SP x AQ) – (SP x SQ) = (AP x AQ) – (SP x SQ)

Variance Analysis: General Description 1. AP x AQ (Actual Quantity of Input at Actual Price) 2. SP x AQ (Actual Quantity of Input at Standard Price) 3. SP x SQ (Standard Quantity of Input at Standard Price) Price Variance (1-2) Usage Variance (2-3) Budget Variance (1-3)

Favorable variances occur whenever the opposite occurs. Unfavorable variances occur whenever actual prices or usage of inputs are greater than standard prices or usage. Favorable variances occur whenever the opposite occurs.

Control Chart Cost x $110,000 $100,000 $ 90,000 Time

Variance Analysis: Materials and Labor Actual production 48,500 bags of corn chips Actual cost of corn 780,000 ounces of $0.0069 = $5,382 Actual cost of inspection labor 360 hours at $7.35 = $2,646 Actual Costs Budgeted Costs Total Variance Corn $5,382.00 $5,238.00 $144.00 U Inspection labor 2,646.00 2,376.50 269.50 U

Variance Analysis: Columnar Approach AQ x AP 780,000 x 0.0069 $5,382 AQ x SP 780,000 x $.0.0060 $4,680 SQ x SP 873,000 x $0.0060 $5,238 $702 U Price Variance $558 F Usage Variance $144 U Total Variance

MPV = (AP – SP)AQ Material Price Variance The actual price per unit The standard price per unit The actual quantity of material used

Material Price Variance MPV = (AP – SP)AQ = ($0.0069 – $0.0060)780,000 = $0.0009 x 780,000 = $702 U Percent of SP x SQ = $702/$4,680 = 15%

MUV = (AQ – SQ)SP Direct Materials Usage Variance The actual quantity of materials used The standard quantity of materials allowed for the actual output The standard price per unit

Direct Materials Usage Variance MUV = (AQ – SQ)SP = (780,000 – 873,000)($0.006) = 93,000 x $0.006 = $558 F Percent of SQ x SP = $558/$5,238 = 10.7%

LRV = (AR – SR)AH Labor Rate Variances The actual hourly wage rate The standard hourly wage rate The actual direct labor hours used

Percent of SR x SH = $126/$2,520 = 5% Labor Rate Variances LRV = (AR – SR)AH = ($7.35 – $7.00)360 = $0.35 x 360 = $126 U Percent of SR x SH = $126/$2,520 = 5%

Labor Variances: Columnar Approach AH x AR 360 x $735 $2,646 AH x SR 360 x $7.00 $2,520 SH x SR 339.5 x $7.00 $2,376.50 $126 U Rate Variance $143.50 U Efficiency Variance $269.50 U Total Variance

LEV = (AH – SH) SR Labor Efficiency Variances The actual direct labor hours used The standard direct labor hours that should have been used The standard hourly wage rate

Percent of SH x SR = $143.50/$2,376.50 = 6% Labor Efficiency Variances LEV = (AH – SH)SR = (360 – 339.5)$7 = 20.5 x $7 = $143.50 U Percent of SH x SR = $143.50/$2,376.50 = 6%

Variable Overhead Variances Variable overhead rate (standard) $3.85/DLH Actual variable overhead costs $1,600 Actual hours worked 400 Bags of chips produced 48,500 Hours allowed for production 373.3 Applied variable overhead $1,456

Variable Overhead Variances: Columnar Approach Actual VO $1,600 VO Rate x Actual Hours $1,540 VO Rate x Standard Hours $1,456 $60 U Spending Variance $84 U Efficiency Variance $144 U Total Variance

VOSV = (AVOR x AH) – (SVOR x AH) Variable Overhead Spending Variances VOSV = (AVOR x AH) – (SVOR x AH) = (AVOR – SVOR)AH = ($4.00 – $3.85)400 = $60 U

Flexible Budget Performance Report For the Week Ended March 8, 2004 Crunch Chips, Inc. Flexible Budget Performance Report For the Week Ended March 8, 2004 Cost Formula Actual Costs Spending Variance Budget Gas $3.00 $1,190 $1,200 $10 F Electricity 0.78 385 312 73 U Water 0.07 25 28 3 F Total cost $3.85 $1,600 $1,540 $60 U

For the Week Ended March 8, 2004 Crunch Chips, Inc. Performance Report For the Week Ended March 8, 2004 Budget for Standard Hours Cost Formula Actual Costs Spending Variance EfficiencyVariance Budget Gas $3.00 $1,190 $1,200 $10 F Electricity 0.78 385 312 73 U Water 0.07 25 28 3 F Total cost $3.85 $1,600 $1,540 $60 U $1,135 $65 U 295 17 U 26 2 U $1,456 $84 U

Fixed Overhead Variances Budgeted or Planned Items Budgeted fixed overhead $749,970 Practical activity 23,400 direct labor hours Standard fixed overhead rate $32.05 Hours allowed to produce 3,000,000 bags of chips: 0.078 x 3,000,000 = $23,400 Actual Results Actual production 2,750,000 bags of chips Actual fixed overhead cost $749,000 Standard hours allowed for actual production 21,450

Total Fixed Overhead Variances Applied fixed overhead Standard fixed overhead rate x Standard hours = = $32.05 x 21,450 = $687,473 (rounded) Total fixed overhead variance $749,000 – $687,473 = = $61,527 underapplied

Fixed Overhead Variances: Columnar Approach Actual FO $749,000 Budgeted FO $749,970 Applied FO $687,473 $970 F Spending Variance $62,497 U Volume Variance $61,527 U Total Variance

Crunch Chips, Inc. Performance Report For the Year Ended 2004 Fixed Overhead Items Actual Costs Budgeted Cost Variance Depreciation $530,000 $530,000 $ ---- Salaries 159,370 159,970 600 F Taxes 50,500 50,000 500 U Insurance 9,130 10,000 870 F Total fixed overhead $749,000 $749,970 $970 F

Volume Variance Volume variance = $32.05(23,400 – 21,450) = ($32.05 x 23,400) – ($32.05 x 21,450) = $749,970 – $687,473 = Budgeted fixed overhead – Applied fixed overhead = $62,497 U

Appendix: Accounting for Variances

Material Price Variance The actual price is $0.0069 per ounce of corn and standard price is $0.0060, and 780,000 ounces of corn are purchased. Materials Inventory 4 680 00 Materials Price Variance 702 00 The receiving report and the invoice are used to record the receipt of the merchandise and to control the payment. Accounts Payable 5 382 00 Material Price Variance

Material Usage Variance During the period 780,000 ounces of corn is placed into production. The standard quantity is 873,000 ounces, and standard price is $0.006. Work in Process 5 238 00 Materials Usage Variance 558 00 The receiving report and the invoice are used to record the receipt of the merchandise and to control the payment. Materials Inventory 4 680 00 Material Usage Variance

During the period the firm has 360 actual inspection hours, while the standard hours for the units produced is 339.5 hours. The actual rate is $7.35 per hour while the standard rate is $7.00 per hour. Work in Process 2 376 00 Labor Efficiency Variance 143 50 Labor Rate Variance 126 00 The receiving report and the invoice are used to record the receipt of the merchandise and to control the payment. Accrued Payroll 2 646 00 Labor Variances

At the end of the year, the variances for materials and labor are usually closed to Cost of Goods Sold. Cost of Goods Sold 971 50 Material Price Variance 702 00 Labor Efficiency Variance 143 50 Labor Rate Variance 126 00 The receiving report and the invoice are used to record the receipt of the merchandise and to control the payment. Closing Variances

At the end of the year, the variances for materials and labor are usually closed to Cost of Goods Sold. Material Usage Variance 558 00 Cost of Goods Sold 558 00 The receiving report and the invoice are used to record the receipt of the merchandise and to control the payment. Closing Variances

Chapter Nine The End