Cost Accounting: Foundations and Evolutions, 8e Kinney ● Raiborn © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Chapter 7: Standard Costing and Variance Analysis

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Learning Objectives How are material, labor, and overhead standards set? How are material, labor, and overhead variances calculated and recorded? Why are standard cost systems used? 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?

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Standard Cost Systems Manufacturing Service Not-for-Profit Record standard and actual costs in the accounting records

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Standards Standard costs are budgeted costs to  Manufacture a single unit of product or  Perform a single service To develop standards, identify  Material and labor types, quantities, and prices  Overhead types and behavior

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Manufacturing Objective Minimize unit cost while achieving certain quality specifications. Input Resources Output Quality

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Material Standards Materials used  Types  Quantity  Quality  Price From  Product specifications, observation, inquiry  Bill of materials Standard Material = Unit Purchase Price * quantity Cost  Balance cost, quality, and projected sales price

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Labor Standards Labor used  Types Production, setup, cleanup, and rework  Quantity  Cost Include wages, payroll taxes, and fringe benefits From  Industrial engineering studies including methods-time measurement (MTM), time and motion studies, historical data  Operations flow document Standard Labor = Hours * Wage Rate Cost

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Overhead Standards Variable and fixed manufacturing overhead Estimated level of activity Estimated costs Predetermined factory overhead application rates

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Standard Cost Card For one unit of output (a bike) Standard Direct Material Components Standard Direct Labor Components Manufacturing Overhead Variable Overhead Fixed Overhead

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Variance  Variance is the difference between an actual cost and a standard cost.

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Total Variance Standard cost of actual production output Actual price of actual production input Total Variance * * Favorable or unfavorable Total actual cost incurred minus total standard cost applied to output produced

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. SP x SQAP x AQ Total Variance 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 Inputs Outputs Total Variance

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. AP x AQSP x SQ Total Variance SP x AQ Price/Rate Variance (AP – SP) x AQ * * Favorable or unfavorable What was paid What should have been paid Price Variance

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. AP x AQSP x SQ Total Variance SP x AQ Usage Variance (AQ – SQ) x SP * * Favorable or unfavorable What should have been used for the level of output What was used Usage Variance

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. AP x AQSP x SQ Total Variance SP x AQ MPV (AP – SP) x AQ * * Favorable or unfavorable What was paid What should have been paid Material Price Variance (MPV)

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. MPV Calculations Calculate MPV at  Point of purchase or  When materials used

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. AP x AQSP x SQ Total Variance SP x AQ MQV (AQ – SQ) x SP * * Favorable or unfavorable What should have been used for level of output What was used Material Quantity Variance (MQV)

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Labor Rate Variance (LRV) AP x AQSP x SQ Total Variance SP x AQ LRV (AP – SP) x AQ * * Favorable or unfavorable What was paid What should have been paid

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Labor Efficiency Variance (LEV) AP x AQSP x SQ Total Variance SP x AQ LEV (AQ – SQ) x SP * * Favorable or unfavorable What should have been used for level of output What was used

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Overhead Variances Variable Overhead Actual variable overhead is total of various ledger accounts SP =Predetermined variable overhead rate Fixed Overhead Actual fixed overhead is total of various ledger accounts SP =Predetermined fixed overhead rate

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. What should have been used for level of output For actual hours used VOH Spending Variance VOH Efficiency Variance Total VOH Variance SP x SQSP x AQ Actual VOH Budgeted VOH Applied VOH Actual Variable Overhead Variances

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. VOH Spending Variance Caused by price differences  Managers have little control over prices Caused by shrinkage or waste  Managers should be held accountable

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Fixed Overhead Variances SP x SQ Actual FOH Budgeted FOH Applied FOH FOH Spending Variance FOH Volume Variance Total FOH Variance Constant Amount What should have been used for level of output

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. FOH Spending and Volume Variance FOH Spending Variance  Calculate variance for each component  Caused by price differences  May reflect mismanagement of resources FOH Volume Variance  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

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Alternative Overhead Variance Approaches One variance Two variance Three variance Four variance

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. One Variance Approach SP x SQ Actual OH Standard Cost of OH Total OH Variance Applied Overhead

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Two Variance Approach SP x SQ Actual OH Budgeted OH based on SQ Standard Cost of OH Budget Variance Volume Variance Total OH Variance Applied Overhead

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Three Variance Approach SP x SQ Actual OH based on Actual Output Standard OH Volume Variance Total OH Variance Budgeted OH based on Actual Inputs OH Spending Variance OH Efficiency Variance Applied Overhead

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Standard Cost Journal Entries Variances recorded in accounting system Favorable variances  Credits  Represent savings in production costs Unfavorable variances  Debits  Represent excess production costs Inventories are recorded at standard cost during the period

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Purchase of Materials (Point of Purchase Method) Materials Accts Pay Materials Price Variance Debit—Unfavorable Credit—Favorable AP x AQ purchased SP x AQ purchased U F At Standard Cost

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Use of Materials WIP Materials Quantity Variance SP x AQ used SP x SQ allowed Debit—Unfavorable Credit—Favorable U F At Standard Cost

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Record Labor Wages Pay LEV AP x AQ WIP SP x SQ allowed LRV Debit—Unfavorable Credit—Favorable At Standard Cost U F

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. SP x SQ Allowed Apply Overhead SP x SQ Allowed WIP FOH VOH SP x SQ Allowed

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Year-End Treatment for VOH Enter a debit or credit to bring balance to zero VOH Efficiency Variance VOH Spending Variance Debit—Unfavorable Credit—Favorable VOH ActualApplied

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Year-End Treatment for FOH FOH Spending Variance Volume Variance FOH ActualApplied Debit—Unfavorable Credit—Favorable Enter a debit or credit to bring balance to zero

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Year-End Treatment of Variances Material Price Variances  Raw Materials  WIP  Finished Goods  Cost of Goods Sold All other variances  WIP  Finished Goods  Cost of Goods Sold Immaterial—Adjust Cost of Goods Sold Material—Prorate variances to:

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Why Use Standard Cost Systems Motivation Planning Controlling — variance analysis Decision making Performance evaluation

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Setting Standards and Trends Setting Standards  Appropriateness  Attainability Expected standards Practical standards Ideal standards Trends in Standards  Ideal Standards and Theoretical Capacity  Adjusting standards  Price variance on purchase versus usage  Decline in direct labor content

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Conversion Costs Combine direct labor and manufacturing overhead Variances  Spending variance for overhead  Efficiency variances for machinery and production costs  Volume variances for production

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Material Price, Mix, and Yield Variances AM x AQ x AP AM x AQ x SP SM x AQ x SP SM x SQ x SP Material Price Variance Material Mix Variance Material Yield Variance What should have been used for level of output? AM — Actual Mix SM — Standard Mix

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Labor Rate, Mix, and Yield Variances AM x AH x AR AM x AH x SR SM x AH x SR SM x SH x SR Labor Rate Variance Labor Mix Variance Labor Yield Variance M—Mix H—Hours R—Rate What should have been used for level of output?

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Questions How are standards set for material, labor, and overhead? How is variance analysis used for control and performance evaluation? Why are labor and overhead elements sometimes combined into a single conversion element?

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Potential Ethical Issues 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