1 Chapter Eleven Standard Costs and Variance Analysis

2 Standards and Standard Costs A standard cost is the per-unit cost a company should incur to make a unit of product. A price and quantity is set for each input

3 Approaches Used To Set Standards Engineering methods Managerial estimates Benchmarking and Best Practices

4 What Standard? An ideal standard can be attained only under perfect conditions. Setting a currently attainable standard recognizes expectations about efficiency under normal working conditions. An historical standard is based on experience.

5 Standards - Pros and Cons Pro: Work well in mature industries where focus is on cost control and price competition Con: Problematic in industries with frequent technical changes in products Don’t encourage improvement

6 Benchmarking Benchmarking is a relatively recent development that companies use to determine whether their operations and costs compare favorably to those of world-class companies.

7 Standard Costs Cost Factor Std. QualityStd. PriceStd. Cost Materials20 feet$0.80$16.00 Direct labor1/2 hour Overhead2.50 $23.50 Actual results: Crates produced1,000 Materials purchased (23,000 feet)$18,860 Direct labor (480 hours at $10.10)$4,848 Overhead$2,400

8 Variance Analysis For each input a price and a quantity standard is determined At the end of the period the actual input cost is compared to the flexible budget and the difference is analyzed into price and quantity effects Price variance is the difference in price paid from standard price times the actual quantity of input Quantity variance is the difference in quantity used from standard quantity allowed times the standard price of the input per unit

9 Generic Variance Analysis

10 Actual Input Quantity at Actual Rates (Total Actual Costs) Flexible Budget Allowance Based on Actual Quantity of Input at Standard Rate Flexible Budget Allowance Based on Actual Quantity of Output at Standard Rate (Total Standard Costs) 18,860 23,000*0.80 = ,000 x 20*0.80 = 16,000 $460 U price variance usage variance $2860U Total Variance $2,400 U Material Variances

11 Actual Input Quantity at Actual Rates (Total Actual Costs) Flexible Budget Allowance Based on Actual Quantity of Input at Standard Rate Flexible Budget Allowance Based on Actual Quantity of Output at Standard Rate (Total Standard Costs) 4, x $ ,000*10*0.5 $48 U rate variance efficiency variance $152 F Total Variance $200 F Labor Variances

12 Overhead Variances Overhead variances consist of the controllable variance and the volume variance Controllable variance is the difference between the actual overhead and the flexible budget for the actual activity level (flexible budget variance) Volume variance is the difference between the applied overhead and the flexible budget. It arises because a different number of units was produced than was used in determining the unit cost. Relates only to fixed overhead.

13 Overhead Cost Development Assume that the overhead budget and volume used to develop the $2.50 per unit were as follows: Budget formulaOH = $1,800 + $0.50 per unit Expected volume is 900 units Overhead is ( (0.50*900))/900 = = $2.50 per unit of which $2.00 is fixed and $0.50 is variable

14 Overhead Variance Analysis Format Actual Overhead $2,400 Flexible Budget for actual output 1, ,000 * ,300 Applied Overhead 1,000 * ,500 Controllable Variance 100 U Volume Variance 200 F

15 Analysis of Overhead Variances Controllable variance is unfavorable because the budget for 1,000 units is $1, ,000*0.50 or $2,300 and the actual spending was $2,400. The volume variance is favorable because more untis were produced that was originally planned (1,000 versus 900). The amount is the fixed cost per unit (1,800/900) times the excess production (100 units)

16 Management by Exception Management by exception says that we assume things are fine unless given information to the contrary. Investigate variances that fall outside of normal limits Also look for trends in variances that are in normal limits.

17 Issues That Complicate the Interpretation of Variances Variances signal nonstandard performance only if they are based on up- to-date standards that reflect current production methods and current prices of input factors. Many variances are interdependent.

18 Nonfinancial Measurers Supplies of inventories Cycle time Setup time Percentage of deliveries to customers made on-time Quality measures Throughput measures