Chapter 7: Standard Costing and Variance Analysis

1. Chapter 7:Standard Costing and Variance Analysis Cost Accounting: Foundations & Evolutions, 9e Kinney and Raiborn

2. Learning Objectives • Why are standard cost systems used? • How are material, labor, and overhead standards set? • How are material, labor, and overhead variances calculated and recorded? • How have the setting and use of standards changed over time? • How does the use of a single conversion element (rather than the traditional labor and overhead elements) affect standard costing? • (Appendix) How are variances affected by multiple material and labor categories?

3. Why Use Standard Cost Systems A standard cost system tracks both standard and actual costs. This dual recording provides an essential element to cost control: having norms against which actual operations can be compared. • Motivating • Planning • Controlling - variance analysis • Clerical efficiency • Decision making • Performance evaluation

4. Setting Standards • Appropriateness • Attainability • Expected standards • Practical standards • Ideal standards

5. 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

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

7. Labor Standards • Labor used • 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, and historical data • Operations flow document

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

9. AP x AQ SP x SQ Total Variance 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

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

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

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

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

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

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

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

17. Actual FOH Budgeted FOH Applied FOH SP x SQ FOH Spending Variance FOH Volume Variance Total FOH Variance Fixed Overhead Variances Constant Amount What should have been used for level of output

18. FOH Spending Variance • Calculate variance for each component • Caused by price differences • May reflect mismanagement of resources

19. FOH Volume Variance • Calculate variance for each component • 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

20. Questions • Why are standard cost systems used? • How are standards set for material, labor, and overhead? • How are material, labor and overhead variances calculated and recorded?

21. 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 • 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