1. STANDARD COSTS AND VARIANCES CHAPTER 11 1 Debbie Garvin, JD; CPA – ACG2071

2. Standard Costs  Budget for a Single Unit  Benchmark or Target for evaluating actual cost  Quantity Standard for DM, DL & MOH  Price Standard for DM, DL & MOH 2

3. Variance Analysis 3  What is Standard Cost Variance  Difference between standard cost/unit and the actual cost/unit  Variance Analysis  Breaking down the differences between standard and actual cost into two components  Price difference and efficiency (quantity) difference  In manufacturing operations, the production costs and controlling these costs are most important  A Price Variance & an Efficiency (quantity) variance computed for all 3 product costs: DM DL MOH

4. Standard Costs & Budgeted Costs 4 Standard Cost per Unit Direct material (2 lbs at $5 per lb)$10 Direct labor (3 hrs at $10 per hr)$30 Manuf. O/H ($5 per DL hr charged)$15 Standard cost per unit $55/ unit

5. Standard Costs & Budgeted Costs 5  Budget for direct materials for year calls for 5,000 pounds of raw materials to make our production goal  Budgeted cost for direct materials for year is $25,000 (5,000 lbs at $5 per lb)  Standards and budgets very similar. Major distinction between the 2 terms is that a standard is a unit amount, whereas a budget is a total amount for the budgeted # of units to be produced.

6. Where do Standard Costs Come From?  Standard Quantity & Price for direct materials may be specified:  In engineering plans that provide a list of materials and price of materials needed to make our product  In recipes or formulas  Standard price of materials often determined from a price list provided by suppliers 6

7. Where do Standard Costs Come From?  Standard Quantity & Price for direct labor may be specified:  By time & motion studies  Through analysis of past data  By management expectations of rates to be paid  Standard costs for overhead involves procedures similar to those used to develop predetermined overhead rates  In developing standards, should Management use ideal standards or attainable standards? 7

8. Price and Quantity Standards Components  Direct materials: Purchase price + freight-in + receiving costs = Standard Cost  Direct labor: Average basic pay rates + payroll taxes + fringe benefits (taking into account normal mix of DL workers) = Standard Cost  Manufacturing overhead – determine resources needed for support activities and determine appropriate allocation base (cost driver) 8

9. Standard Cost – Direct Materials: Kool-Time Pools  Determine standard quantity of DM  Determine standard price of DM 9

10. Standard Cost – Direct Labor: Kool-Time Pools  Determine standard quantity  400 direct labor hours per pool  Determine standard price 10

11. Standard Cost Rate for Overhead  Determine Standard Manufacturing Overhead Rates  Standard predetermined M/O rate for Variable Overhead  Standard predetermined M/O rate for Fixed Overhead  Standard total overhead rate = Standard variable overhead rate + Standard fixed overhead rate Estimated total manuf. overhead cost Estimated total allocation base = Standard predetermined manufacturing overhead rate (either fixed or variable) 11

12. Standard Cost of Inputs  Quantity Standard times Price Standard = Standard Cost of Input per unit Direct Materials Standard Cost/pool 1000 cf x $2.00/cf = $2000 + Direct Labor Standard Cost/pool 400 hrs. x $10.50/hr = $4200 + Variable Overhead Standard Cost (next slide) = Standard Variable Manufacturing Cost per Unit + Fixed Overhead Standard Cost = Standard Manufacturing Cost per Product 12

13. Calculating Standard Total O/H Cost Rate 13  (Mgt estimates variable O/H at $6,400 & fixed O/H at $12,000) Standard Variable Overhead Rate: Est. total Var O/H cost = $6,400 = $2 stndrd variable MOH rate /DLH Est. total allocation base 3,200 DLH Standard Fixed Overhead Rate: Est. total Fixed O/H cost = $12,000 = $3.75 std fixed MOH rate/DLH Est. total allocation base 3,200 DLH Standard Overhead Rate = $2.00 (VOH) + $3.75 (FOH) = $5.75 MOH per DLH

14. Standard Cost of Inputs  Quantity Standard times Price Standard = Standard Cost of Input per unit Direct Materials Standard Cost/pool 1000 cf x $2.00/cf = $2000 + Direct Labor Standard Cost/pool 400 hrs x $10.50/hr = $4200 + Variable Overhead Standard Cost/pool 400 hrs x $2/hr= $800 = Standard Variable Manufacturing Cost per Unit $7,000/pool + Fixed Overhead Standard Cost 400 DL hrs x $3.75/hr= $1,500/pool = Standard Manufacturing Cost per Product $8,500/pool 14

15. Benefits of Standard Costs  Help managers plan  Help managers control costs  Motivate employees  Provide unit costs  Simplify recordkeeping & reduce clerical costs  Product costs recorded in WIP Inv recorded at standard, not actual cost. So variances immediately available 15

16. Drawbacks of Standard Costs  Above only applies if standards are up to date  Info only helpful if variances computed often  If used as targets, be careful  You get what you measure 16

17. Variance Analysis for Pool Co. Actual ResultsFlex. Bud./Act. ProdFlex Budget Variance Variable expenses: Direct Materials $ 23,100$ 20,0003,100 U Direct Labor 41,80042,000200 F Variable Overhead 9,0008,0001,000 U Variable Marketing and Admin 9,10010,000900 F Total Variable Expenses $83,000$80,000$3,000 U Fixed expenses: Fixed Overhead 12,30012,000300 U Fixed Marketing and Admin 9,7008,0001,700 U Total Fixed Expenses 22,00020,0002,000 U Total Expenses $105,000$100,000$5,000 U ab a. Flex budget = 1000 cf/pool x 10 pools x $2.00/cf=$20,000; b. Actual=11,969 cf x $1.93/cf = $23,100 17

18. Variance Components Efficiency VariancePrice Variance Actual Price X Actual Quantity Standard Price X Actual Quantity Standard Price X Standard Quantity Total Cost Variance 18

19. Price (Rate) Variance for DM & DL  Measures how well the business keeps unit costs within standards (for both DM & DL): (Actual Price x Actual Quantity) – (Standard Price x Actual Quantity) so shortened formula (Actual Price – Standard Price) x Actual Quantity purchased/used (AP – SP) x AQ purchased this period DM price variance = actual price of DM – stndrd price of DM x actual quantity of DM purchased DL price (rate) variance: actual price of DL – stndrd price of DL x quantity of DL used 19

20. Efficiency (Quantity) Variance  Efficiency variance measures how well the business uses its direct materials or human resources- direct labor: (Actual Quantity – Standard Quantity used for actual output) x Standard Price (AQ – SQ) x SP Although variance here concerned with physical usage (quantity), it is generally stated in dollar terms to evaluate its importance relative to other dollar amounts such as DM & DL price variance. 20

21. Info for Pool Company 21  Static Budget was based on 8 pools  Co. actually produced and sold 10 pools  DM purchased & used 11,969 cf x $1.93/cf = $23,100  DL used 3800 hours x $11/hr = $41,800  Predetermined Variable OH Rate: $2/DLH ($6,400 ÷ 3200DLH)  Predetermined Fixed OH Rate: $3.75/DLH ($12,000÷3200 DLH)  Actual Variable OH: $9,000  Actual Fixed OH: $12,300

22. Variances for Direct Materials – Pool Co 22  DM Price Var: (Actual Price – Stndrd Price) x Actual Quan used  DM Price Variance = ($1.93/cf - $2.00/cf) x 11,969 cf = $838 F (DM Price Var based on materials purchased – AQP) (In this example, materials purchased = materials used  DM Eff Var: (Actual Quan – Stnd Quan for actual prod) x Stnd Price  DM Eff Var = (11,969 cf – 10,000 cf) x $2/cf = $3,938 Unf (DM Quantity (Eff) Var based on materials used – AQU)  Price Variance + Efficiency Variance = Total Cost Variance  DM Price Var $838F + DM Eff Var $3,938 Unf = $3,100 Unf DM Cost Variance (Flexible Budget Variance)

23. Variances for Direct Labor-Pool Co 23  DL Rate Var: (Actual Rate – Stndrd Rate) x Actual Quan used  DL Rate Var: ($11/hr - $10.50/hr) x 3800 hrs = $1,900 Unf  DL Eff Var: (Act Quan – Stnd Quan for actual prod) x Stnd Price  DL Eff Var: (3800 hrs – 4000 hours) x $10.50/hr = $2,100 Fav  Rate Variance + Efficiency Variance = Total Cost Variance  DL Rate Var $1,900U + DL Eff Var $2,100F = $200F DL Cost Variance (Flexible Budget Variance)  What do these variances tell us?

24. Variances Sales Volume Variance Flexible Budget Variance Actual Results Flexible Budget based on actual number of outputs Static Budget based on expected number of outputs Static Budget Variance Efficiency Variance Price Variance 24

25. Who is Responsible for Each Variances Sales Volume Variance Flexible Budget Variance Actual Results Flexible Budget based on actual number of outputs Static Budget based on expected number of outputs Static Budget Variance Efficiency Variance Price Variance 25 Purchasing Manager Responsible Production Manager Responsible

26. Three Common Pitfalls  Static budgets play no role in computing the flexible budget variance or in determining how split into price & efficiency variances  In computing efficiency (quantity) variance, standard quantity is the standard quantity of inputs allowed for the actual number of outputs  In DM price variance, difference in prices multiplied by actual quantity of DM.  In DM efficiency variance, difference in quantities multiplied by the standard price of DM. 26

27. Practical Tips for Using Variances  Compute variances frequently  Using variances to evaluate employees’ performance?  Variances a way to raise questions, not as indicators of good or poor performance Variance may be caused by factors manager cannot control Variance may be result of inaccurate or outdated standards Managers often make trade-offs among variances Purchasing manager may buy more expensive raw materials in hopes of cutting down on waste, so trade off of unfavorable price variance for favorable efficiency variance which may improve overall Company performance 27

28. Co. Manufactured 200,000 boat fenders during year, using 1,450,000 feet of extruded vinyl purchased at $1.05 per foot. Production required 4,500 direct labor hrs. that cost $14/hr. Materials standard was 7 feet of vinyl/fender at standard cost of $1.10/foot. The labor standard was 0.025 direct labor hour per fender at a standard cost of $13/hour. Compute price & efficiency variances for DM & DL. Does pattern of variances suggest that Co.’s managers have been making trade-offs?  DM: Actual price/foot $1.05  Standard price/foot $1.10  Actual quantity used 1,450,000 feet  Standard quantity allowed (200,000 units x 7) 1,400,000 feet  DL: Actual price per hour $14  Standard price per hour $13  Actual quantity used 4,500 hours Standard quantity allowed (200,000 units x.025) 5,000 hours 28

29. Calculate Materials Price Variance Materials price variance: Actual Quantity = 1,450,000 feet purchased & used Actual Price = $1.05/ft Standard Price = $1.10/ft (Actual Price – Standard Price) x Actual Quantity used ($1.05 - $1.10) x 1,450,000 feet = $72,500 F 29

30. Calculate Material Efficiency(Quan) Variance Materials efficiency variance: Actual Quantity = 1,450,000 feet Standard Quantity = 200,000 fenders x 7’ = 1,400,000’ Standard Price = $1.10/ft (Actual Quantity–Standard Quantity) x Standard Price (1,450,000-1,400,000) x $1.10 = $55,000 U Large favorable DM price variance ($72,500) and large unfavorable DM efficiency variance ($55,000) – what might this mean? 30

31. Calculate Labor Price Variance Labor price variance: Actual Quantity = 4,500 hours Actual Price = $14.00/hr Standard Price = $13.00/hr Basic Avg wage rate$10 + Employment taxes at 10% of basic rate 1 + Fringe Benefits at 20% of basic rate 2 Standard rate per DL hour$13 (Actual Price – Standard Price) x Actual Quantity ($14 - $13) x 4,500 hours = $4,500 Unf Labor Price Variance 31

32. Calculate Labor Efficiency Variance Labor efficiency variance: Actual Quantity = 4,500 hrs. Standard Quantity = 200,000 fenders x.025 std dlh/fender = 5,000 hrs. Standard Price = $13.00/hr (Actual Quantity–Standard Quantity) x Standard Price (4,500hrs – 5,000hrs) x $13 = $6,500 Fav DL Eff Var Unfavorable DL price variance ($4,500) and favorable DL efficiency variance ($6,500) = $2,000 Fav DL Variance: – what might this mean? 32

33. Manufacturing Overhead Costs 33  2 Variable MOH Variances  Variable OH Rate (Spending) Variance  Variable OH Efficiency Variance  2 Fixed MOH Variances  Fixed MOH Budget (Spending) Variance  Fixed MOH Volume Variance  How is MOH allocated to product?  Predetermined OH allocation rate  Co.’s total MOH variance is difference between actual OH incurred and standard OH allocated to production by POHR  Amount by which MOH has been over or under allocated to product cost

34. Variable OH Rate (Spending) Variance 34  Tells whether more or less was spent on variable OH than expected for the hours (cost driver) worked  Actual Hours x (Actual Rate – Standard Rate)  AH x (AR – SR) Variable OH Efficiency Variance  Tells how much of total variable OH due to using more or fewer hours of allocation base than anticipated for actual volume of output  Standard Rate x (Actual Hrs. – Standard Hrs. Allowed)  SR x (AH – SHA)

35. Fixed Overhead Budget (Spending) Variance 35  Measures difference between actual fixed OH costs incurred budgeted fixed OH costs  Difference between Actual fixed OH & Budgeted fixed OH  Favorable if actual OH costs less than budgeted

36. Fixed Overhead Volume Variance 36  Measures difference between budgeted fixed OH & standard fixed OH allocated to products  Fixed overhead volume variance = budgeted fixed overhead – standard overhead cost allocated to production  Occurs when actual prod volume differs from budgeted volume, arises due to Co. treating fixed OH as var cost in order to allocate it  Favorable if volume higher than estimated (more units produced w/same amount of fixed resources)  Unf if volume lower than estimated (fixed costs not used to produce as many units as estimated)

37. Fixed Overhead Volume Variance 37  In essence, measures the utilization of the fixed capacity costs And…the fixed overhead volume variance is favorable Then…fixed overhead has been over allocated If… production volume is greater than anticipated If…production volume is less than anticipated And…the fixed overhead volume variance is unfavorable Then…fixed overhead has been under allocated

38. Variable OH Variances for Pool Co. 38 Variable OH Rate Variance: Actual hrs. x (Actual Rate – Stnd Rate) 3800 hrs. x ($2.37* - $2.00) = $1,406 Unf *Actual rate is Actual Var OH $9,000÷3800 actual DLH= $2.368 Stnd rate Variable OH Efficiency Variance: Stnd Rate x (Actual hrs. – Stnd hrs. allowed) $2 x (3,800 hrs. – 4,000 hrs (10 pools x 400hrs/pool) $2 x 200 hrs. = $400 Fav Total Variable MOH Variance = $1,006 Unf

39. Fixed OH Variances for Pool Co. 39 Fixed OH Budget Variance: Actual Fixed OH – Budgeted Fixed OH $12,300 - $12,000 = $300 Unf Fixed OH Volume Variance: Budgeted Fixed OH – Standard FOH allocated to production* $12,000 - $15,000 (400 stnd DLhrs. x $3.75 stnd rate x 10 pools) = $3,000 Fav (more produced than budgeted) *If Co using standard cost accounting system, allocate Fixed MOH to production by multiplying predetermined MOH rate by standard quantity of cost driver (DLH or MH) rather than actual quantity of cost driver (DLH or MH) used.

40. Variance Overhead Variances 40 Actual VOH Applied VOH AH x AR AH x SR SH x SR 3800hrs x $2.37 3800hrs x $2 4000hrs x $2 $9006$7600$8,000 Variable OH Rate Variance Variable OH Efficiency Variance $1406 (Unf) $400 (Fav) (Actual Rate > StdRate) (Actual Hrs < Std Hrs) Total Variable OH Variance $1006 Unf (Sl 17)

41. Fixed Overhead Variances 41 Actual Fixed O/HBudgeted Fixed O/H Applied Fixed O/H $12,300$12,000 $15,000 Fixed O/H Spending Var Fixed O/H Volume Var $300 Unf $3000 Fav

42. 42 Gator Co makes plastic Gator Lawn Statues. Standard costs are: Direct Materials5 lbs/unit at cost of $3/lb Direct Labor2 hrs at cost of $18/hr Standard Variable MOH rate $10/DLH Budgeted Fixed MOH $8,800 Standard Fixed MOH rate $2.50/DLH Gator allocates fixed MOH to products based on standard DLHs. Last month, Gator produced 2,000 statues with following actual results: Direct MaterialsPurchased 10,800 lbs at cost of $4/lb; Used 10,300 lbs to produce 2,000 units Direct LaborWorked 2.1 hrs/unit at cost of $18.60/hr Actual Variable MOH$10.50/DLH; Total of $44,100 Actual Fixed MOH$10,200 Stndrd Fixed MOH allocated based on actual production $10,000 Calculate & interpret DM; DL & MOH Variances

43. 43 Price Variance: (Actual Price – Stnd Price) x Actual Quantity Purchased $4 - $3 x 10,800 lbs. = $10,800 Unf Quantity Variance: (Actual Quantity Used – Stnd Quan) x Stnd Price $10,300 lbs. – 10,000 lbs. (2000 units x 5lbs/unit) = $900 Unf Total DM Cost Variance: $10,800 Unf + $900 Unf = $11,700 Unf Unf Price Variance: Go to Purchasing Mgr., we paid higher price for raw materials than budgeted, why? Didn’t get order in on time for Discounts built into budget; or raw material cost increased since budget Unf Quantity Variance: Go to Production Mgr., why did production workers use more direct materials than called for in Budget? Inferior R. M. purchased so lots of waste; or production workers careless with R.M.? DM Variances

44. Direct Labor Variances 44 Rate Variance: (Actual Price – Stnd Price) x Actual Quan used ($18.60 - $18) x 4,200 hrs (2.1hrs x 2000units) = $2,520 Unf Efficiency Variance : (Actual Quan Used – Stnd Quan) x Stnd Price 4,200 hrs – 4,000 hrs (2hrs x 2000 units) x $18/hr = $3,600 Unf Total DL Cost Variance: $2,520 Unf + $3,600 Unf = $6,120 Unf Unf Rate Variance: Go to Human Resources (Payroll), why did we pay more to our workers than budgeted? Or ask Production Supervisor, did we use more higher paid workers than budgeted in our mix of workers since lower paid workers always call in sick on Friday. Unf Efficiency Variance: Go to Production Supervisor, why did it take our production workers longer to produce units than budgeted?

45. Variable MOH Variances 45 Rate Variance: Actual Hrs x (Actual Rate – Stndrd Rate) 4,200 hrs x ($10.50/DLH - $10.00/DLH) = $2,100 Unf Efficiency Variance: Stnd Rate x (Actual Hrs – Stndrd Hrs) $10 x (4,200 hrs – 4,000* hrs) = $2,000 Unf *(2 hrs x 2000 units) Unf Rate Variance: Actual amount of Variable MOH greater than budgeted amount given the direct labor hours used which was more than Budgeted. Go to Production Supervisor and ask why, since that person most familiar with costs in Variable MOH. Unf Efficiency Variance: Actual hours used were greater than the standard hours allowed.

46. Fixed MOH Variances 46 Budget Variance: Actual fixed MOH – Budgeted fixed MOH $10,200 - $8,800 = $1,400 Unf Volume Variance : Budgeted Fixed MOH – Stnd MOH Allocated to Production $8,800 - $10,000(4,000 Stnd hrs x Stnd fixed MOH rate $2.50)=$1,200 F Unf Budget Variance: Greater fixed MOH costs were incurred than budgeted. Might go to Production Supervisor or Accounting Dept to question why. Fav Volume Variance: Production Volume was greater than budgeted

47. Standard Cost Accounting Systems  Product costs recorded at standard costs, not actual costs  Managers can compare differences (variances) between standard & actual costs every day Isolates price & efficiency variances as they occur Each type of variance has its own general ledger account If debit balance, variance Unf (decreases income like expense) If credit balance, variance Fav (increases income like revenue) 47

48. Standard Cost Accounting Systems  Just as in job costing system, product costs in SCAS flow through inv accnts in same order: RM → WIP → FG → COGS  Difference is that standard costs rather than actual costs used to record manufacturing costs recorded in inventory accounts  At end of period, variances closed to COGS to “correct” for using standard costs in accounts rather than actual costs So COGS on Income Statement adjusted to correct balance on Fin. Sts. since most of inventory worked on during year was sold 48

49. Standard Costing has been Main Accounting System in Manufacturing Companies for Decades: Why? 49  For cost control purposes; provides basis for cost comparisons  Makes no sense to compare budgeted costs at one planned level of activity w/actual costs incurred at different level of activity  Standard costs enable managerial accountants to compute standard cost at actual output, which then serves as a benchmark to compare w/actual cost

50. Standard Costing has been Main Accounting System in Manufacturing Companies for Decades: 50  Computation of standard costs & cost variances enable managers to employ management by exception – this approach conserves valuable management time, how define exceptional variances? Absolute size of the variance is one method, management more likely to follow up on large variances than on small ones But relative size of variance is probably more important Manager more likely to investigate a $20,000 material quantity variance that is 20% of standard DM cost of $100,000 than a $50,000 labor efficiency variance that is only 2% of standard DL cost of $2,500,000

51. 51  Variances provide means of performance evaluation for employees, therefore they motivate employees to adhere to standards  Use of standard costs in product costing results in more stable product cost for decision making than if actual production costs used. Actual costs often fluctuate erratically, whereas standard cost changed only periodically Standard Costing has been Main Accounting System in Manufacturing Companies for Decades:

52. END OF SEGMENT Debbie Garvin, JD; CPA – ACG2071