Chapter 8 Standard Costs Chapter 8: Standard Costs.

Chapter 8 Standard Costs Chapter 8: Standard Costs.
This chapter begins our study of management control and performance measures. It explains how standard costs are used by managers to control costs.

Standard Costs Standards are benchmarks or “norms” for measuring performance. Two types of standards are commonly used. Quantity standards specify how much of an input should be used to make a product or provide a service. Cost (price) standards specify how much should be paid for each unit of the input. A standard is a benchmark or “norm” for measuring performance. In managerial accounting, two types of standards are commonly used by manufacturing, service, food and not-for-profit organizations:  Quantity standards specify how much of an input should be used to make a product or provide a service. For example: a. Auto service centers like Firestone and Sears set labor time standards for the completion of work tasks. b. Fast-food outlets such as McDonald’s have exacting standards for the quantity of meat used in a sandwich.  Cost (price) standards specify how much should be paid for each unit of the input. For example: a. Hospitals have standard costs for food, laundry, and other items b. Home construction companies have standard labor costs that they apply to sub-contractors such as framers, roofers, and electricians. c. Manufacturing companies often have highly developed standard costing systems that establish quantity and cost (price) standards for each separate product’s material, labor and overhead inputs. These standards are listed on a standard cost card.

Manufacturing Overhead
Standard Costs Deviations from standard deemed significant are brought to the attention of management, a practice known as management by exception. Standard Amount Direct Material Management by exception is a system of management in which standards are set for various operating activities, with actual results compared to these standards. Any deviations that are deemed significant are brought to the attention of management as “exceptions.” This chapter applies the management by exception principle to quantity and cost (price) standards with an emphasis on manufacturing applications. Direct Labor Manufacturing Overhead Type of Product Cost

Variance Analysis Cycle
Identify questions Receive explanations Take corrective actions Conduct next period’s operations Analyze variances The variance analysis cycle is a continuous five-step process: The cycle begins with the preparation of standard cost performance reports in the accounting department. These reports highlight variances that are differences between actual results and what should have occurred according to standards. Variances raise questions such as: a. Why did this variance occur? b. Why is this variance larger than it was last period? Significant variances are investigated to discover their root causes. Corrective actions are taken and the next period’s operations are carried out. Prepare standard cost performance report Begin

Learning Objective 1 Explain how direct materials standards and direct labor standards are set. Learning objective number 1 is to explain how direct materials standards and direct labor standards are set.

Setting Standard Costs
Accountants, engineers, purchasing agents, and production managers combine efforts to set standards that encourage efficient future production. Setting price and quantity standards requires the combined expertise of everyone who has responsibility for purchasing and using inputs. In a manufacturing setting, this might include managerial accountants, engineers, purchasing managers, production supervisors, line managers, and production workers. Standards should be designed to encourage efficient future operations, not just a repetition of past inefficient operations.

Setting Standard Costs
I recommend using practical standards that are currently attainable with reasonable and efficient effort. Should we use ideal standards that require employees to work at 100 percent peak efficiency? Standards tend to fall into one of two categories: Ideal standards can only be attained under the best of circumstances. They allow for no work interruptions, and they require employees to continually work at 100 percent peak efficiency. Practical standards are tight, but attainable. They allow for normal machine downtime and employee rest periods and can be attained through reasonable, highly efficient efforts of the average worker. Practical standards can also be used for forecasting cash flows and in planning inventory. Engineer Managerial Accountant

Setting Direct Material Standards
Price Standards Quantity Standards Summarized in a Bill of Materials. Final, delivered cost of materials, net of discounts. The standard price per unit for direct materials should reflect the final, delivered cost of the materials, net of applicable discounts. The standard quantity per unit for direct materials should reflect the amount of material required for each unit of finished product, as well as an allowance for unavoidable waste, spoilage, and other normal inefficiencies. A bill of materials is a list that shows the quantity of each type of material in a unit of finished product.

Setting Standards The zero defects mentality that underlies improvement programs such as Six Sigma argues against accepting waste and spoilage. If allowances for waste and spoilage are built into the standard quantity, the level of those allowances should be reduced over time. The zero defects mentality that underlies improvement programs such as Six Sigma argues against accepting waste and spoilage. If allowances for waste and spoilage are built into the standard quantity, the level of those allowances should be reduced over time.

Setting Direct Labor Standards
Rate Standards Often a single rate is used that reflects the mix of wages earned. Time Standards Use time and motion studies for each labor operation. Instead of the terms price and quantity used for material, we use rate and time when we apply standard cost concepts to direct labor. Labor rates can be determined by wage surveys of rates paid in comparable companies or by labor contracts. The standard rate per hour for direct labor includes not only wages earned, but also fringe benefits and other labor costs. Many companies prepare a single rate for all employees within a department that reflects the “mix” of wage rates earned. The standard hours per unit reflects the labor hours required to complete one unit of product. Standard times can be determined by using available references that estimate the time needed to perform a given task, or by relying on time and motion studies.

Setting Variable Overhead Standards
Price Standards The rate is the variable portion of the predetermined overhead rate. Quantity Standards The activity is the base used to calculate the predetermined overhead. The price standard for variable manufacturing overhead comes from the variable portion of the predetermined overhead rate. The quantity standard for variable manufacturing overhead is usually expressed in either direct labor hours or machine hours depending on which is used as the allocation base in the predetermined overhead rate.

Standard Cost Card – Variable Production Cost
A standard cost card for one unit of product might look like this: The standard cost card is a detailed listing of the standard amounts of direct materials, direct labor, and variable overhead inputs that should go into a unit of product, multiplied by the standard price or rate that has been set for each input.

Standards vs. Budgets A standard is a per unit cost.
Standards are often used when preparing budgets. Are standards the same as budgets? A budget is set for total costs. A standard is a unit amount, whereas a budget is a total amount. A standard can be viewed as the budgeted cost for one unit of product. Standards are often used in the preparation of budgets.

Price and Quantity Standards
Price and and quantity standards are determined separately for two reasons: The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used. Price and and quantity standards are determined separately for two reasons Different managers are usually responsible for buying and for using inputs. For example: The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used. The buying and using activities occur at different points in time. For example: Raw material purchases may be held in inventory for a period of time before being used in production. The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production.

A General Model for Variance Analysis
Price Variance Difference between actual price and standard price Quantity Variance Difference between actual quantity and standard quantity Differences between standard prices and actual prices and standard quantities and actual quantities are called variances. The act of computing and interpreting variances is called variance analysis.

Price Variance Quantity Variance Price and quantity variances can be computed for all three variable cost elements – direct materials, direct labor, and variable manufacturing overhead – even though the variances have different names as shown. Materials price variance Labor rate variance VOH spending variance Materials quantity variance Labor efficiency variance VOH efficiency variance

Price Variance Quantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Although price and quantity variances are known by different names, they are computed exactly the same way (as shown on this slide) for direct materials, direct labor, and variable manufacturing overhead.

Price Variance Quantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Actual quantity is the amount of direct materials, direct labor, and variable manufacturing overhead actually used. The actual quantity represents the actual amount of direct materials, direct labor, and variable manufacturing overhead used.

Price Variance Quantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price Standard quantity is the standard quantity allowed for the actual output for the period. The standard quantity represents the standard quantity allowed for the actual output of the period.

Price Variance Quantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price The actual price represents the actual amount paid for the input used. Actual price is the amount actually paid for the input used.

Price Variance Quantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price The standard price represents the amount that should have been paid for the input used. Standard price is the amount that should have been paid for the input used.

Price Variance Quantity Variance Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price In equation form, price and quantity variances are calculated as shown. (AQ × AP) – (AQ × SP) (AQ × SP) – (SQ × SP) AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity

Learning Objective 2 Compute the direct materials price and quantity variances and explain their significance. Learning objective number 2 is to compute the direct materials price and quantity variances and explain their significance.

Material Variances Example
Glacier Peak Outfitters has the following direct material standards for the fiberfill in its mountain parka. 0.1 kg. of fiberfill per parka at $5.00 per kg. Last month, 210 kgs of fiberfill were purchased and used to make 2,000 parkas. The material cost a total of $1,029. Here’s an example that will give us an opportunity to compute price and quantity variances for materials.

Material Variances Summary
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 210 kgs kgs kgs × × × $4.90 per kg $5.00 per kg $5.00 per kg. = $1, = $1, = $1,000 The materials price variance, defined as the difference between what is paid for a quantity of materials and what should have been paid according to the standard, is $21 favorable. The materials price variance is favorable because the actual price was less than the standard price by 10 cents per kilogram. The materials quantity variance, defined as the difference between the quantity of materials used in production and quantity that should have been used according to the standard, is $50 unfavorable. The materials quantity variance is unfavorable because the actual quantity exceeds the standard quantity allowed by 10 kilograms. Price variance $21 favorable Quantity variance $50 unfavorable

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 210 kgs kgs kgs × × × $4.90 per kg $5.00 per kg $5.00 per kg. = $1, = $1, = $1,000 $1,029  210 kgs = $4.90 per kg The actual price is $4.90 per kilogram which is computed by dividing the actual cost of the materials by the actual number of kilograms purchased. Price variance $21 favorable Quantity variance $50 unfavorable

Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 210 kgs kgs kgs × × × $4.90 per kg $5.00 per kg $5.00 per kg. = $1, = $1, = $1,000 0.1 kg per parka  2,000 parkas = 200 kgs The standard quantity of materials is 200 kilograms which is computed by multiplying the standard quantity per parka times the number of parkas made. Price variance $21 favorable Quantity variance $50 unfavorable

Material Variances: Using the Factored Equations
Materials price variance MPV = AQ (AP - SP) = 210 kgs ($4.90/kg - $5.00/kg) = 210 kgs (-$0.10/kg) = $21 F Materials quantity variance MQV = SP (AQ - SQ) = $5.00/kg (210 kgs-(0.1 kg/parka 2,000 parkas)) = $5.00/kg (210 kgs kgs) = $5.00/kg (10 kgs) = $50 U The equations that we have been using thus far can be factored and used to compute materials price and quantity variances. We can determine the materials price variance by multiplying the actual quantity times the difference between the actual price and the standard price. We can determine the materials quantity variance by multiplying the standard price times the difference between the actual quantity and the standard quantity.

Isolation of Material Variances
I need the price variance sooner so that I can better identify purchasing problems. You just don’t understand the problems that purchasing managers have. I’ll start computing the price variance when material is purchased rather than when it’s used. Most companies compute the materials price variance when materials are purchased. They calculate the materials quantity variance after materials are used in production.

Material Variances The price variance is computed on the entire quantity purchased. The quantity variance is computed only on the quantity used. Hanson purchased and used 1,700 pounds. How are the variances computed if the amount purchased differs from the amount used? The materials price variance is computed using the entire amount of materials purchased during the period. The materials quantity variance is computed using only the portion of materials that was used in production during the period.

Responsibility for Material Variances
Materials Quantity Variance Materials Price Variance Purchasing Manager Production Manager The purchasing manager and production manager are usually held responsible for the materials price variance, and materials quantity variance, respectively. The standard price is used to compute the quantity variance so that the production manager is not held responsible for the performance of the purchasing manager. The standard price is used to compute the quantity variance so that the production manager is not held responsible for the purchasing manager’s performance.

Responsibility for Material Variances
Your poor scheduling sometimes requires me to rush order material at a higher price, causing unfavorable price variances. I am not responsible for this unfavorable material quantity variance. You purchased cheap material, so my people had to use more of it. The materials variances are not always entirely controllable by one person or department. For example, the production manager may schedule production in such a way that it requires express delivery of raw materials resulting in an unfavorable materials price variance. The purchasing manager may purchase lower quality raw materials resulting in an unfavorable materials quantity variance for the production manager.

1.5 pounds per Zippy at $4.00 per pound
Quick Check  Zippy Hanson Inc. has the following direct materials standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound Last week, 1,700 pounds of material were purchased and used to make 1,000 Zippies. The material cost a total of $6,630. In this example the company produces a Zippy. The direct materials standard calls for 1.5 pounds per Zippy at $4 per per pound. Last week, Hanson purchased and used 1,700 of material to produce 1,000 Zippies. The 1,700 pounds of material cost a total of $6,630. Using the information provided on this slide, several questions will be asked, so you may want to take some notes to use as you answer the questions. Try to answer each question before advancing to the solution.

Quick Check  Hanson’s material price variance (MPV) for the week was:
Zippy Hanson’s material price variance (MPV) for the week was: a. $170 unfavorable. b. $170 favorable. c. $800 unfavorable. d. $800 favorable. Here’s your first question.

Quick Check  Hanson’s material price variance (MPV) for the week was:
Zippy Hanson’s material price variance (MPV) for the week was: a. $170 unfavorable. b. $170 favorable. c. $800 unfavorable. d. $800 favorable. MPV = AQ(AP - SP) MPV = 1,700 lbs. × ($ ) MPV = $170 Favorable We find the materials price variance by multiplying the actual quantity of materials purchased times the difference between the actual price per pound and the standard price per pound. We find the actual price per pound by dividing the $6,630 total actual price paid for the materials by the 1,700 pounds purchased. The $170 favorable materials price variance results because Hanson paid 10 cents per pound less than standard for 1,700 pounds of material.

Quick Check  Zippy Hanson’s material quantity variance (MQV) for the week was: a. $170 unfavorable. b. $170 favorable. c. $800 unfavorable. d. $800 favorable. Here’s your second question.

Quick Check  Zippy Hanson’s material quantity variance (MQV) for the week was: a. $170 unfavorable. b. $170 favorable. c. $800 unfavorable. d. $800 favorable. The standard quantity is the amount of material that Hanson should have used to make 1,000 Zippies. We find the standard quantity by multiplying the 1.5 pounds per unit standard for one Zippy times the 1,000 Zippies. Now that we know the standard quantity, let’s calculate the material quantity variance. We find the material quantity variance by multiplying the standard price for one pound of material times the difference between the actual quantity of material and the standard quantity of material. The $800 unfavorable material quantity variance results because Hanson used 200 pounds more than standard to make the 1,000 Zippies, and each pound of material has a standard price of $4. MQV = SP(AQ - SQ) MQV = $4.00(1,700 lbs - 1,500 lbs) MQV = $800 unfavorable

Quick Check  Zippy Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price 1,700 lbs ,700 lbs ,500 lbs × × × $3.90 per lb $4.00 per lb $4.00 per lb. = $6, = $ 6, = $6,000 Here we see a summary of the material price and quantity variance computations in a convenient three-column format. You may find this three-column format more helpful than the equations that we used to answer the previous two questions. Price variance $170 favorable Quantity variance $800 unfavorable

Quick Check  Continued
Zippy Hanson Inc. has the following materials standard to manufacture one Zippy: 1.5 pounds per Zippy at $4.00 per pound Last week, 2,800 pounds of material were purchased at a total cost of $10,920, and 1,700 pounds were used to make 1,000 Zippies. Let’s extend the Hanson example by increasing the quantity of material purchased to 2,800 pounds at a total cost of $10,920. All other information is the same as before.

Zippy Actual Quantity Actual Quantity Purchased Purchased × × Actual Price Standard Price 2,800 lbs ,800 lbs × × $3.90 per lb $4.00 per lb. = $10, = $11,200 Hanson actually paid $10,920 for the 2,800 pounds of materials. Multiplying the standard price of $4 per pound times the 2,800 pounds of materials purchased, we find that Hanson should have paid $11,200. The price variance is now $280 favorable. The price variance increased in this example because the quantity purchased increased. The $280 favorable materials price variance results because Hanson paid 10 cents per pound less than standard for 2,800 pounds of material. Price variance $280 favorable Price variance increased because quantity purchased increased.

Zippy Actual Quantity Used Standard Quantity × × Standard Price Standard Price 1,700 lbs ,500 lbs × × $4.00 per lb $4.00 per lb. = $6, = $6,000 The material quantity variance is the same as before because Hanson used the same amount of material as before to make the same number of Zippies. Quantity variance is unchanged because actual and standard quantities are unchanged. Quantity variance $800 unfavorable

Learning Objective 3 Compute the direct labor rate and efficiency variances and explain their significance. Learning objective number 3 is to compute the direct labor rate and efficiency variances and explain their significance.

Labor Variances Example
Glacier Peak Outfitters has the following direct labor standard for its mountain parka. 1.2 standard hours per parka at $10.00 per hour Last month, employees actually worked 2,500 hours at a total labor cost of $26,250 to make 2,000 parkas. Now let’s turn our attention back to Glacier Peak Outfitters to illustrate the computation of labor rate and efficiency variances.

Labor Variances Summary
Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours ,500 hours ,400 hours × × × $10.50 per hour $10.00 per hour $10.00 per hour = $26, = $25, = $24,000 The labor rate variance, defined as the difference between the actual average hourly wage paid and the standard hourly wage, is $1,250 unfavorable. The rate variance is labeled unfavorable because the actual average wage rate was more than the standard wage rate by $0.50 per hour. The labor efficiency variance, defined as the difference between the actual quantity of labor hours and the quantity allowed according to the standard, is $1,000 unfavorable. The efficiency variance is labeled unfavorable because the actual quantity of hours exceeds the standard quantity allowed by 100 hours. Rate variance $1,250 unfavorable Efficiency variance $1,000 unfavorable

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours ,500 hours ,400 hours × × × $10.50 per hour $10.00 per hour $10.00 per hour = $26, = $25, = $24,000 $26,250  2,500 hours = $10.50 per hour The actual wage rate is $10.50 per hour, computed by dividing the actual total cost for labor by the actual number of hours worked. Rate variance $1,250 unfavorable Efficiency variance $1,000 unfavorable

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours ,500 hours ,400 hours × × × $10.50 per hour $10.00 per hour $10.00 per hour = $26, = $25, = $24,000 1.2 hours per parka  2,000 parkas = 2,400 hours The standard quantity of labor hours is 2,400 hours, computed by multiplying the standard hours for one parka times the number of parkas made. Rate variance $1,250 unfavorable Efficiency variance $1,000 unfavorable

Labor Variances: Using the Factored Equations
Labor rate variance LRV = AH (AR - SR) = 2,500 hours ($10.50 per hour – $10.00 per hour) = 2,500 hours ($0.50 per hour) = $1,250 unfavorable Labor efficiency variance LEV = SR (AH - SH) = $10.00 per hour (2,500 hours – 2,400 hours) = $10.00 per hour (100 hours) = $1,000 unfavorable The equations that we have been using thus far can be factored and used to compute labor rate and efficiency variances. We can determine the labor rate variance by multiplying the actual hours times the difference between the actual rate and the standard rate. We can determine the labor efficiency variance by multiplying the standard rate times the difference between actual hours and standard hours.

Responsibility for Labor Variances
Production managers are usually held accountable for labor variances because they can influence the: Mix of skill levels assigned to work tasks. Level of employee motivation. Quality of training provided to employees. Quality of production supervision. Production Manager Labor variances are partially controllable by employees within the production department. For example, production managers/supervisors can influence the: Deployment of highly skilled workers and less skilled workers on tasks consistent with their skill levels; Level of employee motivation within the department; Quality of production supervision; and Quality of the training provided to the employees.

Responsibility for Labor Variances
I think it took more time to process the materials because the Maintenance Department has poorly maintained your equipment. I am not responsible for the unfavorable labor efficiency variance! You purchased cheap material, so it took more time to process it. However, labor variances are not entirely controllable by one person or department. For example: The Maintenance Department may do a poor job of maintaining production equipment. If this increases the processing time required per unit, it will cause an unfavorable labor efficiency variance. The purchasing manager may purchase lower quality raw materials resulting in an unfavorable labor efficiency variance for the production manager.

1.5 standard hours per Zippy at $12.00 per direct labor hour
Quick Check  Zippy Hanson Inc. has the following direct labor standard to manufacture one Zippy: 1.5 standard hours per Zippy at $12.00 per direct labor hour Last week, 1,550 direct labor hours were worked at a total labor cost of $18,910 to make 1,000 Zippies. Let’s return to the Hanson Company and compute labor variances. The direct labor standard to produce each Zippy is 1.5 hours at $12 per hour. Last week, it took 1,550 direct labor hours to produce 1,000 Zippies, and the total labor cost was $18,910. Now, we will be asked several questions based on the information on this screen. Again, you may wish to take some notes to use as you answer the questions. Also, just as you did with the material variance questions, try to answer each question before advancing to the solution.

Quick Check  Hanson’s labor rate variance (LRV) for the week was:
Zippy Hanson’s labor rate variance (LRV) for the week was: a. $310 unfavorable. b. $310 favorable. c. $300 unfavorable. d. $300 favorable. Here’s your first labor variance question.

Quick Check  Hanson’s labor rate variance (LRV) for the week was:
Zippy Hanson’s labor rate variance (LRV) for the week was: a. $310 unfavorable. b. $310 favorable. c. $300 unfavorable. d. $300 favorable. LRV = AH(AR - SR) LRV = 1,550 hrs($ $12.00) LRV = $310 unfavorable We find the actual labor rate by dividing the $18,910 total labor cost by 1,550 direct labor hours actually worked. Now that we know the actual labor rate, let’s calculate the labor rate variance. We find the labor rate variance by multiplying the actual labor hours worked times the difference between the actual rate per labor hour and the standard rate per labor hour. The $310 unfavorable labor rate variance results because Hanson paid 20¢ per labor hour more than standard for 1,550 labor hours actually worked.

Quick Check  Zippy Hanson’s labor efficiency variance (LEV) for the week was: a. $590 unfavorable. b. $590 favorable. c. $600 unfavorable. d. $600 favorable. Here’s your second labor variance question.

Quick Check  Zippy Hanson’s labor efficiency variance (LEV) for the week was: a. $590 unfavorable. b. $590 favorable. c. $600 unfavorable. d. $600 favorable. The total standard hours for labor is the amount of time Hanson’s employees should have worked to make 1,000 Zippies. We find the total standard hours by multiplying the 1.5 standard hours for one Zippy times the 1,000 Zippies made. Now that we know the total standard hours, let’s calculate the labor efficiency variance. We find the labor efficiency variance by multiplying the standard rate for one hour of labor times the difference between the actual hours of labor and the standard hours of labor. The $600 unfavorable labor efficiency variance results because Hanson’s employees worked 50 hours more than standard to make 1,000 Zippies, and each hour of labor has a standard rate of $12. LEV = SR(AH - SH) LEV = $12.00(1,550 hrs - 1,500 hrs) LEV = $600 unfavorable

Quick Check  Zippy Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 1,550 hours ,550 hours ,500 hours × × × $12.20 per hour $12.00 per hour $12.00 per hour = $18, = $18, = $18,000 Here we see a summary of the labor rate and efficiency variance computations in a convenient three-column format. You may find this three-column format more helpful than the equations that we used to answer the previous two questions. Rate variance $310 unfavorable Efficiency variance $600 unfavorable

Learning Objective 4 Compute the variable manufacturing overhead spending and efficiency variances. Learning objective number 4 is to compute the variable manufacturing overhead spending and efficiency variances.

Variable Manufacturing Overhead Variances Example
Glacier Peak Outfitters has the following direct variable manufacturing overhead labor standard for its mountain parka. 1.2 standard hours per parka at $4.00 per hour Last month, employees actually worked 2,500 hours to make 2,000 parkas. Actual variable manufacturing overhead for the month was $10,500. Now that we have studied material and labor variances, let’s take a look a variable manufacturing overhead variances. We will return to Glacier Peak Outfitters to illustrate the computation of variable manufacturing spending and efficiency variances.

Variable Manufacturing Overhead Variances Summary
Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours ,500 hours ,400 hours × × × $4.20 per hour $4.00 per hour $4.00 per hour = $10, = $10, = $9,600 The variable overhead spending variance, defined as the difference between the actual variable overhead costs incurred during the period and the standard cost that should have been incurred based on the actual activity of the period, is $500 unfavorable. The spending variance is labeled unfavorable because the actual variable overhead rate was more than the standard variable overhead rate by $0.20 per hour. The variable overhead efficiency variance, defined as the difference between the actual activity of a period and the standard activity allowed, multiplied by the variable part of the predetermined overhead rate, is $400 unfavorable. The efficiency variance is labeled unfavorable because the actual quantity of the activity (hours) exceeds the standard quantity of the activity allowed by 100 hours. Spending variance $500 unfavorable Efficiency variance $400 unfavorable

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours ,500 hours ,400 hours × × × $4.20 per hour $4.00 per hour $4.00 per hour = $10, = $10, = $9,600 $10,500  2,500 hours = $4.20 per hour The actual variable manufacturing overhead rate is $4.20 per hour, computed by dividing the actual total cost for variable manufacturing overhead by the actual number of hours worked. Spending variance $500 unfavorable Efficiency variance $400 unfavorable

Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 2,500 hours ,500 hours ,400 hours × × × $4.20 per hour $4.00 per hour $4.00 per hour = $10, = $10, = $9,600 1.2 hours per parka  2,000 parkas = 2,400 hours The standard quantity for labor hours is 2,400 hours, computed by multiplying the standard hours for one parka times the number of parkas made. Spending variance $500 unfavorable Efficiency variance $400 unfavorable

Variable Manufacturing Overhead Variances: Using Factored Equations
Variable manufacturing overhead spending variance VMSV = AH (AR - SR) = 2,500 hours ($4.20 per hour – $4.00 per hour) = 2,500 hours ($0.20 per hour) = $500 unfavorable Variable manufacturing overhead efficiency variance VMEV = SR (AH - SH) = $4.00 per hour (2,500 hours – 2,400 hours) = $4.00 per hour (100 hours) = $400 unfavorable The equations that we have been using thus far can be factored and used to compute the variable manufacturing overhead variances. We can determine the variable manufacturing overhead spending variance by multiplying the actual hours times the difference between the actual rate and the standard rate. We can determine the variable manufacturing overhead efficiency variance by multiplying the standard rate times the difference between actual hours and standard hours.

1.5 standard hours per Zippy at $3.00 per direct labor hour
Quick Check  Zippy Hanson Inc. has the following variable manufacturing overhead standard to manufacture one Zippy: 1.5 standard hours per Zippy at $3.00 per direct labor hour Last week, 1,550 hours were worked to make 1,000 Zippies, and $5,115 was spent for variable manufacturing overhead. Now let’s return to the Hanson company and compute the variable manufacturing overhead variances. The variable manufacturing overhead standard to produce each Zippy is 1.5 at $3 per hour. Last week, it took 1,550 hours to produce 1,000 Zippies, and the total variable manufacturing overhead cost was $5,115. Using the information provided on this slide, several questions will be asked, so you may want to take some notes to use as you answer the questions posed. Also, just as you did with the materials and labor variance questions, try to answer each question before advancing to the solution.

Quick Check  Zippy Hanson’s spending variance (VOSV) for variable manufacturing overhead for the week was: a. $465 unfavorable. b. $400 favorable. c. $335 unfavorable. d. $300 favorable. Here’s your first variable manufacturing overhead variance question.

Quick Check  Zippy Hanson’s spending variance (VOSV) for variable manufacturing overhead for the week was: a. $465 unfavorable. b. $400 favorable. c. $335 unfavorable. d. $300 favorable. VOSV = AH(AR - SR) VOSV = 1,550 hrs($ $3.00) VOSV = $465 unfavorable We find the actual variable manufacturing overhead rate by dividing the $5,115 total variable manufacturing overhead cost by 1,550 direct labor hours actually worked. Now that we know the actual variable manufacturing overhead rate, let’s calculate the variable manufacturing overhead spending variance. We find the variable manufacturing overhead spending variance by multiplying the actual hours worked times the difference between the actual variable manufacturing overhead rate per hour and the standard variable manufacturing overhead rate per hour. The $465 unfavorable variable manufacturing overhead rate variance results because Hanson’s actual variable manufacturing overhead rate per labor hour is 30¢ per hour more than the standard variable manufacturing overhead rate per hour for the 1,550 labor hours actually worked.

Quick Check  Zippy Hanson’s efficiency variance (VOEV) for variable manufacturing overhead for the week was: a. $435 unfavorable. b. $435 favorable. c. $150 unfavorable. d. $150 favorable. Here’s your second variable manufacturing overhead variance question.

Quick Check  Zippy Hanson’s efficiency variance (VOEV) for variable manufacturing overhead for the week was: a. $435 unfavorable. b. $435 favorable. c. $150 unfavorable. d. $150 favorable. The total standard hours is the amount of time Hanson’s employees should have worked to make 1,000 Zippies. We find the total standard hours by multiplying the 1.5 standard hours for one Zippy times the 1,000 Zippies made. Now that we know the total standard hours, let’s calculate the variable manufacturing overhead efficiency variance. We find the variable manufacturing overhead efficiency variance by multiplying the standard rate for variable manufacturing overhead times the difference between the actual hours of labor and standard hours of labor. The $150 unfavorable variable manufacturing overhead efficiency variance results because Hanson’s employees worked 50 hours more than standard to make 1,000 Zippies at a standard variable manufacturing overhead rate of $3 per hour. 1,000 units × 1.5 hrs per unit VOEV = SR(AH - SH) VOEV = $3.00(1,550 hrs - 1,500 hrs) VOEV = $150 unfavorable

Quick Check  Zippy Actual Hours Actual Hours Standard Hours × × × Actual Rate Standard Rate Standard Rate 1,550 hours ,550 hours ,500 hours × × × $3.30 per hour $3.00 per hour $3.00 per hour = $5, = $4, = $4,500 Just as we did with labor and material variances, we can summarize the variable manufacturing overhead variance computations in a convenient three-column format. You may find this three-column format more helpful than the equations that we used to answer the previous two questions. Spending variance $465 unfavorable Efficiency variance $150 unfavorable

Variance Analysis and Management by Exception
Larger variances, in dollar amount or as a percentage of the standard, are investigated first. All variances are not worth investigating. Methods for highlighting a subset of variances as exceptions include: Looking at the size of the variance. Looking at the size of the variance relative to the amount of spending. How do I know which variances to investigate?

Advantages of Standard Cost Systems
Standard costs are a key element of the management by exception approach which helps managers focus their attention on the most important issues. Standards that are viewed as reasonable by employees can serve as benchmarks that promote economy and efficiency. Standard costs can greatly simplify bookkeeping. Standard costs fit naturally into a responsibility accounting system. Standard cost systems offer many advantages including: Standard costs are a key element of the management by exception approach which helps managers focus their attention on the most important issues. Standards that are viewed as reasonable by employees can serve as benchmarks that promote economy and efficiency. Standard costs can greatly simplify bookkeeping. Standard costs fit naturally into a responsibility accounting system.

Potential Problems with Standard Costs
Emphasizing standards may exclude other important objectives. Favorable variances may be misinterpreted. Potential Problems Emphasis on negative may impact morale. Standard cost reports may not be timely. The use of standard costs can also present a number of problems. For example: Standard cost variance reports are usually prepared on a monthly basis and are often released days or weeks after the end of the month; hence, the information can be outdated; If variances are misused as a club to negatively reinforce employees, morale may suffer and employees may make dysfunctional decisions; Labor variances make two important assumptions. First, they assume that the production process is labor-paced; if labor works faster, output will go up. Second, the computations assume that labor is a variable cost. These assumptions are often invalid in today’s automated manufacturing environment, where employees are essentially a fixed cost; In some cases, a favorable variance can be as bad or worse than an unfavorable variance; Excessive emphasis on meeting the standards may overshadow other important objectives, such as maintaining and improving quality, on-time delivery, and customer satisfaction; and Just meeting standards may not be sufficient; continual improvement may be necessary to survive in a competitive environment. Invalid assumptions about the relationship between labor cost and output. Continuous improvement may be more important than meeting standards.

The Balanced Scorecard
A balanced scorecard consists of an integrated set of performance measures that are derived from and support a company’s strategy. Specific Company Strategy A balanced scorecard consists of an integrated set of performance measures that are derived from and support a company’s strategy. Importantly, the measures included in a company’s balanced scorecard are unique to its specific strategy. Performance measures included in the balanced scorecard.

The Balanced Scorecard
Specific Company Strategy Financial Performance Measures Nonfinancial Performance Measures Nonfinancial measures of performance (related to attributes such as quality and customer satisfaction) are used in addition to financial measures such as standard cost variances. These nonfinancial measures typically tie directly to a company’s strategy in a cause-and-effect manner and they serve as leading indicators of the company’s financial success. Example: Standard Cost Variances. Examples: Product Quality Customer Satisfaction.

General Ledger Entries to Record Variances.
Appendix 8A General Ledger Entries to Record Variances. Appendix 8A: General Ledger Entries to Record Variances.

Prepare journal entries to record standard costs and variances.
Learning Objective 5 Prepare journal entries to record standard costs and variances. Learning objective number 5 is to prepare journal entries to record standard costs and variances.

Appendix 8A Journal Entries to Record Variances
We will use information from the Glacier Peak Outfitters example presented earlier in the chapter to illustrate journal entries for standard cost variances. Recall the following: Material AQ × AP = $1,029 AQ × SP = $1,050 SQ × SP = $1,000 MPV = $21 F MQV = $50 U Labor AH × AR = $26,250 AH × SR = $25,000 SH × SR = $24,000 LRV = $1,250 U LEV = $1,000 U Standard costs and variance analysis can be used without formal journal entries. However, recording inventories and cost of goods sold using standard costs simplifies bookkeeping, since it eliminates the need to keep track of the actual costs of each unit. We will use the information from the Glacier Peak Outfitters example presented earlier in the chapter to illustrate journal entries for labor and material variances. A summary of the standard cost variance computations for Glacier Peak Outfitters’ labor and material variances is shown on your screen. Now, let’s prepare the entries to record the labor and material variances.

The first entry is to to record the purchase of materials. A favorable materials price variance is recorded with a credit. The second entry is to record the use of material. The use of materials involve a transfer from the raw materials inventory to the work-in-process inventory, both asset accounts. An unfavorable materials quantity variance is recorded with a debit. Note that the price variance is recorded at purchase, and the quantity variance is recorded sometime later as materials are used.

Here we see the entry for the incurrence of direct labor. Both labor variances are unfavorable and are recorded with debits. Variable manufacturing overhead variances are usually not recorded in the accounts separately, but rather are determined as part of the general analysis of overhead that is covered in the next chapter. Variable manufacturing overhead variances are usually not recorded in the accounts separately, but rather are determined as part of the general analysis of overhead.

Cost Flows in a Standard Cost System
Inventories are recorded at standard cost. Variances are recorded as follows: Favorable variances are credits, representing savings in production costs. Unfavorable variances are debits, representing excess production costs. Standard cost variances are usually closed to cost of goods sold. Favorable variances decrease cost of goods sold. Unfavorable variances increase cost of goods sold. Entries into the various accounts are made at standard cost – not actual cost. Differences between actual and standard costs are entered into special accounts that accumulate the various standard cost variances. Standard cost variance accounts are usually closed out to Cost of Goods Sold at the end of the period. Unfavorable variances increase Cost of Goods Sold, and favorable variances decrease Cost of Goods Sold.

End of Chapter 8 End of chapter 8.

Chapter 8 Standard Costs Chapter 8: Standard Costs.

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Chapter 8 Standard Costs Chapter 8: Standard Costs.

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