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: Price standards – Final cost of materials after delivery and net of discounts Quantity standards – Use product design specifications Direct Labor Standards: Rate standards – Use labor contracts, wage surveys Time standards – Use time and motion studies Variable Overhead Standards: 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. Chocolate Co. Standard Cost For One Chocolate In 2010 Standard quantity of input to make one chocolate Standard price of input Standard cost of input per chocolate Direct Materials 1 $7 Direct Labor .5 DLH $10/DLH $5 Variable overhead .5DLH $6/DLH $3 Fixed overhead Total standard cost per unit $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 3lb. 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 standard? Was the price paid for plastic different from the standard?

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 for Product A

Direct Material Variances When Quantity Of Materials Purchased Is Not Equal To The Quantity Of Materials Used In Production AQxAP AQxSP SQxSP 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 Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours AH × AR AH × SR SH × SR Rate Variance Efficiency Variance The general model for computing both variable overhead variances is now shown on your screen. Note that the efficiency variance is based on the difference between actual hours and standard hours. Rate variance = AH(AR - SR) Efficiency variance = SR(AH - SH)

Variable Overhead Variances – Example ColaCo’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. . We will illustrate the computation of variable overhead spending and efficiency variances with an example. ColaCo’s actual production for the period required three thousand two hundred standard machine hours. Actual variable overhead incurred for the period was six thousand seven hundred forty dollars. Actual machine hours worked were three thousand three hundred. The standard variable overhead cost per machine hour is two dollars. First we will compute the variable overhead spending variance using actual hours. Then, we will use standard hours allowed with actual hours to compute the variable overhead efficiency variance.

Quick Check  a. $450 U b. $450 F c. $700 F d. $700 U 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  a. $450 U b. $450 F c. $250 F d. $250 U 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 Overhead from the flexible budget for the denominator level of activity POHR = 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 Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied DH × FR SH × FR Here we see the general model for computing fixed overhead variances. The fixed overhead budget variance is the difference between actual fixed overhead incurred and budgeted fixed overhead. The volume variance is the difference between budgeted fixed overhead and fixed overhead applied to production. In equation form, the volume variance is equal to the fixed portion of the predetermined overhead rate times the difference between denominator hours and standard hours allowed. Budget Variance Volume Variance FR = Standard Fixed Overhead Rate SH = Standard Hours Allowed DH = Denominator Hours

Overhead Rates and Overhead Analysis – Example ColaCo prepared this flexible budget for overhead: Total Variable Total Fixed Machine Variable Overhead Fixed Overhead Hours Overhead Rate Overhead Rate 3,000 $ 6,000 ? $ 9,000 ? 4,000 8,000 ? 9,000 ? ColaCo prepared a flexible budget for overhead at two levels of activity, three thousand machine hours and four thousand machine hours. Notice that total variable overhead increases when activity increases, while total fixed overhead is the same at both levels of activity. Let’s calculate overhead rates. ColaCo applies overhead based on machine-hour activity.

Fixed Overhead Variances – Example ColaCo’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 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 Does not measure over- or under spending It results from treating fixed overhead as if it were a variable cost. 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 The volume variance does not measure over-or under-spending. It is a measure of utilization of facilities. In essence, the volume variance is the error that occurs as a result of treating fixed overhead as though it were a variable cost. Next, we will look at two questions that will require us to compute fixed overhead budget and volume variances.

Quick Check  a. $350 U b. $350 F c. $100 F d. $100 U 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