Standard Costing and Variance Analysis Cost Accounting Foundations and Evolutions Kinney and Raiborn Seventh Edition Chapter 7 Standard Costing and Variance Analysis COPYRIGHT © 2009 South-Western, a part of Cengage Learning. South-Western is a trademark used herein under license.

Learning Objectives (1 of 2) Describe how standards are set for material, labor, and overhead List the documents that are associated with standard cost systems and describe the information that those documents provide Calculate and record material, labor, and overhead variances

Learning Objectives (2 of 2) Explain why standard cost systems are used Identify changes in the use of standards Contrast the traditional labor and overhead elements to a single conversion element (Appendix) Explain how multiple material and labor categories affect variances

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

Material Standards Materials used Types Quantity Quality Price From Product specifications, observation, inquiry Bill of materials Balance cost, quality, and projected sales price

Labor Standards Labor used From 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

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

Total Variance SP x SQ AP x AQ Total Variance Inputs Outputs 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

Material Price Variance (MPV) AP x AQ SP x SQ Total Variance SP x AQ MPV What was paid What should have been paid (AP - SP) x AQ* *Favorable or unfavorable

Material Price Variance Calculate Material Price Variance at point of purchase, or when materials used

Material Quantity Variance (MQV) AP x AQ SP x SQ Total Variance SP x AQ MQV What was used What should have been used for level of output (AQ - SQ) x SP* *Favorable or unfavorable

Labor Rate Variance (LRV) AP x AQ SP x SQ Total Variance SP x AQ LRV What was paid What should have been paid (AP - SP) x AQ* *Favorable or unfavorable

Labor Efficiency Variance (LEV) AP x AQ SP x SQ Total Variance SP x AQ LEV What was used What should have been used for level of output (AQ - SQ) x SP* *Favorable or unfavorable

Variable Overhead Variances VOH Spending Variance VOH Efficiency Variance Total VOH Variance SP x SQ SP x AQ Actual VOH Budgeted VOH Applied VOH Actual For actual hours used What should have been used for level of output

VOH Spending Variance Caused by price differences managers have little control over prices Caused by shrinkage or waste managers should be held accountable

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

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

Three Variance Approach Budgeted OH Actual OH Standard OH based on Actual inputs based on actual output SP x SQ VOH & FOH Spending Variance OH Efficiency Variance Volume Variance Total OH Variance Applied Overhead

Why Use Standard Cost Systems Clerical efficiency Motivation Planning Controlling - variance analysis Decision making Performance evaluation

Setting Standards Appropriateness Attainability Expected standards Practical standards Ideal standards

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?

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

Potential Ethical Issues 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