1. Lecture 6 Cost Variances for Direct Costs

2. The derivation of the price and efficiency variances AP ACTUAL COST AQ AP = actual price per unit of input (e.g., price per yard). Q = quantity of inputs for total output (e.g., yards).

3. The flexible budget SP FLEXIBLE BUDGET SQ SP = budgeted price per unit of input (e.g., price per yard). SQ = budgeted quantity of inputs required for total output achieved (e.g., total yards of fabric that should have been needed for actual production).

4. The variable cost flexible budget variance (in green) Actual Price Standard Price FLEXIBLE BUDGET Standard Actual Quantity P = price per unit of input. Q = quantity of inputs for total output.

5. The price variance Actual Price Standard Price FLEXIBLE BUDGET PRICE VARIANCE Standard Actual Quantity S.Q. = standard quantity for actual outputs AP = actual price per unit of input. SP = budgeted price per unit of input. Q = quantity of inputs for total output.

6. The efficiency (or quantity) variance Actual Price Standard Price FLEXIBLE BUDGET Standard Actual Quantity QUANTITY VARIANCE S.Q. = standard quantity for actual outputs AP = actual price per unit of input. SP = budgeted price per unit of input. Q = quantity of inputs for total output.

7. The variable cost flexible budget variance decomposes into a “price” variance and an “efficiency” variance Actual Price Standard Price FLEXIBLE BUDGET PRICE VARIANCE Standard Actual Quantity QUANTITY VARIANCE S.Q. = standard quantity for actual outputs AP = actual price per unit of input. SP = budgeted price. Q = quantity of inputs for total output.

8. The variable cost flexible budget variance decomposes into a “price” variance and an “efficiency” variance Actual Price Standard Price FLEXIBLE BUDGET PRICE VARIANCE Standard Actual Quantity QUANTITY VARIANCE S.Q. = standard quantity for actual outputs AP = actual price per unit of input. SP = budgeted price. Q = quantity of inputs for total output (e.g., yards). why price?

9. Abbreviations: Price or Wage Rate or Spending Variance = PV Quantity or Usage or Efficiency Variance = QV Actual quantity of inputs = AQ Standard quantity of inputs = SQ Actual price per input unit = AP Standard price per input unit = SP The variable cost flexible budget variance decomposes into a “price” variance and an “efficiency” variance

10. Formulas: PV = AQ x (AP - SP) QV = SP x (AQ - SQ) For direct materials, AQ sometimes refers to materials purchased, instead of materials used. In this case, the price variance and the efficiency variance will not sum to the flexible budget variance, due to the timing difference. These variances apply to direct materials, direct labor, and variable overhead.

11. The McBean Company makes stars. The budgeted cost for each star is as follows: Materials: 2 pounds of “star stuff” at $4 per lb. = $8 per star Labor: 1.5 hours at $12 per hour = $18 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25 per lb. Of this amount, 2,300 lbs. were used in production. Direct labor cost was $20,930 for 1,820 hours. 1. What is the direct material price variance, assuming that the company recognizes the price variance at the time the materials are purchased? 2. What is the direct material usage (quantity) variance? 3. What is the direct labor rate (price) variance? 4. What is the direct labor efficiency variance?

12. Formulas: PV = AQ x (AP - SP)QV = SP x (AQ - SQ) PV = Price Variance QV = Quantity Variance AQ (SQ) = Actual (Standard) quantity of inputs AP (SP) = Actual (Standard) price per input Standards for Direct materials: 2 lbs of “star stuff” at $4 per lb. = $8 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” was purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. What is the direct material price variance, assuming that the company recognizes the price variance at the time materials are purchased?

13. Standards for Direct materials: 2 lbs. of “star stuff” at $4 per lb. = $8 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. What is the direct material price variance, assuming that the company recognizes the price variance at the time materials are purchased? PV = AQ x (AP - SP) = 2,600 lbs. x ($4.25 per lb. - $4.00 per lb.) = 2,600 lb. x $0.25 per lb. = $650 Unfavorable

14. Formulas: PV = AQ x (AP - SP)QV = SP x (AQ - SQ) PV = Price Variance QV = Quantity Variance AQ (SQ) = Actual (Standard) quantity of inputs AP (SP) = Actual (Standard) price per input Standards for Direct materials: 2 lbs. of “star stuff” at $4 per lb. = $8 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. 2. What is the direct material usage (quantity) variance?

15. Standards for Direct materials: 2 lbs. of “star stuff” at $4 per lb. = $8 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. 2. What is the direct material usage (quantity) variance? QV = SP x (AQ - SQ) = $4 per lb. x (2,300 lbs. - 2,400 lbs.*) = $4 per lb. x 100 lbs. = $400 favorable * 2 lbs. per star x 1,200 stars

16. Formulas: PV = AQ x (AP - SP)QV = SP x (AQ - SQ) PV = Price Variance QV = Quantity Variance AQ (SQ) = Actual (Standard) quantity of inputs AP (SP) = Actual (Standard) price per input Standards for Direct labor: 1.5 hours at $12 per hour = $18 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. Direct labor cost was $20,930 for 1,820 hours. 3. What is the direct labor rate (price) variance?

17. Standards for Direct labor: 1.5 hours at $12 per hour = $18 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. Direct labor cost was $20,930 for 1,820 hours. 3. What is the direct labor rate (price) variance? PV = AQ x (AP - SP) = 1,820 hr.s x (11.50 per hr* - $12 per hr) = 1,820 hr.s x $0.50 per hr = $910 favorable * $20,930 ÷ 1,820 hours = $11.50 per hr.

18. Formulas: PV = AQ x (SP - AP)QV = SP x (AQ - SQ) PV = Price Variance QV = Quantity Variance AQ (SQ) = Actual (Standard) quantity of inputs AP (SP) = Actual (Standard) price per input Standards for Direct labor: 1.5 hours at $12 per hour = $18 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. Direct labor cost was $20,930 for 1,820 hours. 4. What is the direct labor efficiency variance?

19. Standards for Direct labor: 1.5 hours at $12 per hour = $18 per star In December, 1,200 stars were produced. 2,600 lbs. of “star stuff” were purchased at $4.25/lb. Of this, 2,300 lbs. were used in production. Direct labor cost was $20,930 for 1,820 hours. 4. What is the direct labor efficiency variance? QV = SP x (AQ - SQ) = $12 per hour x (1,820 hrs - 1,800 hrs*) = $12 per hour x 20 hrs. = $240 Unfav. * 1,200 stars x 1.5 hours per star = 1,800 hr.s