Standard costing and variance analysis
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Standard Costing and Variance Analysis. Acc 2203 workshop Sindhu bala. Variances. Managers use variance analysis to compare actual results with expected results and to investigate why actual results differ from expectations for performance evaluation purposes.

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Standard Costing and Variance Analysis

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Standard costing and variance analysis

Standard Costing and Variance Analysis

Acc 2203 workshop

Sindhu bala


Variances

Variances

Managers use variance analysis to compare actual results with expected results and to investigate why actual results differ from expectations for performance evaluation purposes.

A firm sets standards for production costs to articulate its expectations with respect to its operational performance and financial results. Setting production cost standards requires a collaborative effort by accountants, engineers, personnel administrators, and production managers

  • Direct Material Standards:

    • Price standards – Final cost of materials after delivery and net of discounts

    • Quantity standards – Use product design specifications

  • Direct Labor Standards:

    • Rate standards – Use labor contracts, wage surveys

    • Time standards – Use time and motion studies

  • Variable Overhead Standards:

    • Rate standards – Variable portion of the predetermined overhead rate

    • Activity standards – Expected usage of the allocation base

  • Fixed Overhead Standards:

    • Fixed portion of predetermined overhead rate


Example chocolate co

Example – Chocolate Co.


Variance analysis

Variance Analysis

Cost variance – the difference between actual cost and expected/budgeted/standard cost

Favorable cost variance – occurs when actual cost is lower than expected cost for a given level of output

Unfavorable cost variance – occurs when actual cost is greater than expected cost for a given level of output

Do favorable cost variances always signal that the company has performed well in keeping its costs down?


A general framework for variance analysis

Price Variance

Quantity Variance

AQ (AP-SP)

SP (AQ-SQ)

A General Framework For Variance Analysis

  • IMPORTANT NOTE: SQ is the standard quantity allowed for the ACTUAL units produced


A general framework for variance analysis1

Price Variance

Quantity Variance

AQ (AP-SP)

SP (AQ-SQ)

A General Framework For Variance Analysis

  • IMPORTANT NOTE: SQ is the standard quantity allowed for the ACTUAL units produced

Total Variance


General framework for variance analysis

General Framework for Variance Analysis


Direct material variances example 3

Direct Material Variances – Example 3

The Cane Company produced 500 industrial plastic containers. The standard cost of making each container is 3lb. of plastic at $1.5/lb. (same as above).

SQx SP

Standard quantity of plastic Standard price of plastic

allowed for producing 500 containers

3 lb./container x 500 containers = 1,500 lb. x$1.5/lb =$2,250

To make 500 containers the company purchased and used 2,000 lb. of plastic and incurred $4,000 for the cost of plastic.

Total Variance:

The cause of the variance: Was the plastic quantity different from the standard? Was the price paid for plastic different from the standard?


Formulas for computing dm variances

Formulas for computing DM variances

  • Materials price variance =

    AQ x AP – SP x AQ = AQ (AP – SP)

  • Materials quantity variance =

    AQ x SP – SP x SQ = SP (AQ – SQ)

  • Compute the materials price variance and materials quantity variance for the Cane Company using the last example

    DM price variance =

    DM quantity variance =

    In the last example, the Cane Company purchased expensive materials that cost the company $1,000 more than expected; the materials were not used as efficiently as expected costing the company an additional $750. How can the company act on this information?


Standard costing and variance analysis

Direct Material Variances When Quantity Of Materials Purchased Is Not Equal To The Quantity Of Materials Used In Production

When quantity of materials purchased is not equal to the quantity of materials used in production:

-Compute materials price variance using quantity of materials purchased

-Compute materials quantity variance using quantity of materials used in production

Example: Mert Company uses a standard cost system. Information for raw materials for Product A for the month of October follows:

  • Standard price per pound of raw materials:$1.60

  • Actual purchase price per pound of raw materials:$1.55

  • Actual quantity of raw materials purchased:2,000 pounds

  • Actual quantity of raw materials used:1,900 pounds

  • Standard quantity allowed for actual production:1,800 pounds

    Compute Mert’s materials price variance and materials quantity variance for Product A


Standard costing and variance analysis

Direct Material Variances When Quantity Of Materials Purchased Is Not Equal To The Quantity Of Materials Used In Production

AQxAPAQxSPSQxSP

  • Explain why the quantity of materials purchased is more appropriate in calculating materials price variance than the quantity of materials used in production


Concept check

Concept Check

1. The standard and actual prices per pound of raw material are $4.00 and $4.50, respectively. A total of 10,500 pounds of raw material was purchased and then used to produce 5,000 units. The quantity standard allows two pounds of the raw material per unit produced. What was the materials quantity variance?

a. $5,000 unfavorable

b. $5,000 favorable

c. $2,000 favorable

d. $2,000 unfavorable

2. Referring to the facts in question 1 above, what was the material price variance?

a. $5,250 favorable

b. $5,250 unfavorable

c. $5,000 unfavorable

d. $5,000 favorable


Concept check1

Concept Check

3. The actual direct labor wage rate is $8.50 and 4,500 direct labor hours were actually worked during the month. The standard direct labor wage rate is $8.00 and the standard quantity of hours allowed for the actual level of output was 5,000 direct labor hours. What was the direct labor efficiency variance?

a. $4,000 favorable

b. $4,000 unfavorable

c. $4,500 unfavorable

d. $4,500 favorable

4. Referring to the facts in question 3 above, what is the variable overhead efficiency variance if the standard variable overhead per direct labor hour is $5.00?

a. $5,000 favorable

b. $5,000 unfavorable

c. $2,500 unfavorable

d. $2,500 favorable


Variable overhead variances

Variable Overhead Variances

Actual Flexible Budget Flexible Budget Variable for Variable for Variable Overhead Overhead at Overhead at Incurred Actual Hours Standard Hours

AH × AR

AH × SR

SH × SR

Rate Variance

EfficiencyVariance

Rate variance = AH(AR - SR)

Efficiency variance = SR(AH - SH)


Variable overhead variances example

Variable Overhead Variances – Example

ColaCo’s actual production for the period required 3,200 standard machine hours. Actual variable overhead incurred for the period was $6,740. Actual machine hours worked were 3,300. The standard variable overhead cost per machine hour is $2.00.

Compute the variable overhead rate variance and variable overhead efficiency variance.

.


Quick check

Quick Check 

Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the variable overhead rate variance?

a. $450 U

b. $450 F

c. $700 F

d. $700 U


Quick check1

Quick Check 

Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual variable overhead for the period was $10,950. Actual direct labor hours worked were 2,050. The predetermined variable overhead rate is $5 per direct labor hour. What was the VOH efficiency variance?

a. $450 U

b. $450 F

c. $250 F

d. $250 U


Overhead rates and overhead analysis

Overhead Rates and Overhead Analysis

Recall that overhead costs are assigned to products and services using apredetermined overhead rate (POHR):

Assigned Overhead = POHR × Standard Activity

Overhead from theflexible budget for thedenominator level of activity

POHR =

Denominator level of activity


Overhead rates and overhead analysis1

Overhead Rates and Overhead Analysis

The predetermined overhead rate can also be broken down into fixed and variable components:

The variable component is useful for preparing and analyzing variable overhead variances.

The fixed component is useful for preparing and analyzing fixed overhead variances.


Normal versus standard cost systems

Normal versus Standard Cost Systems

In a normal cost system, overhead is applied to work in process based on the actual number of hours worked in the period.

In a standard cost system, overhead is applied to work in process based on the standard hours allowed for the output of the period.


Standard costing and variance analysis

Fixed Overhead Variances

Actual Fixed Fixed Fixed Overhead Overhead Overhead Incurred Budget Applied

DH × FR

SH × FR

VolumeVariance

Budget Variance

FR = Standard Fixed Overhead RateSH = Standard Hours AllowedDH = Denominator Hours


Overhead rates and overhead analysis example

Overhead Rates and OverheadAnalysis – Example

ColaCo prepared this flexible budget for overhead:

Total

Variable

Total

Fixed

Machine

Variable

Overhead

Fixed

Overhead

Hours

Overhead

Rate

Overhead

Rate

3,000

$

6,000

?

$

9,000

?

4,000

8,000

?

9,000

?

Let’s calculate overhead rates.

ColaCo applies overhead basedon machine-hour activity.


Fixed overhead variances example

Fixed Overhead Variances – Example

ColaCo’s actual production required 3,200standard machine hours. Actual fixed overhead was $8,450. The predetermined overhead rate is based on 3,000 machine hours.

What is the budget variance?

The volume variance?


Volume variance a closer look

VolumeVariance

Results when standard hoursallowed for actual output differsfrom the denominator activity.

Unfavorablewhen standard hours< denominator hours

Favorablewhen standard hours> denominator hours

Volume Variance – A Closer Look


Volume variance a closer look1

VolumeVariance

Does not measure over- or under spending

Results when standard hoursallowed for actual output differsfrom the denominator activity.

It results from treating fixedoverhead as if it were avariable cost.

Unfavorablewhen standard hours< denominator hours

Favorablewhen standard hours> denominator hours

Volume Variance – A Closer Look


Quick check2

Quick Check 

Yoder Enterprises’ actual production for the period required 2,100 standard direct labor hours. Actual fixed overhead for the period was $14,800. The budgeted fixed overhead was $14,450. The predetermined fixed overhead rate was $7 per direct labor hour. What was the budget variance?

a. $350 U

b. $350 F

c. $100 F

d. $100 U


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