CHAPTER 4: STANDARD COSTING AND VARIANCE ANALYSIS Standard — a performance benchmark or norm used for planning and control purposes. It specifies the expected costs and quantities needed to manufacture a single unit of product or perform a single service. Standard cost system — a product costing system that determines product cost by using standards or norms for quantities and/or prices of component elements; it allows actual costs to be compared against norms for control purposes. It helps managers plan (budget) and control spending by setting standards for every aspect of the production or service process, from the price that should be paid for ingredients to the amount of time it should take to serve each customer. The standards are set in advance to reflect what managers think cost should be. We will rely on two types of standards, quantity and price standards (Note: after management has determined the input resources needed to achieve desired output quantity at reasonable cost, it can develop quantity and price standards). 1. Quantity standard. The amount of input that should be used in each unit of product or service. This indicates the quantity of raw materials or labor time required to produce a unit of product. This is normally expressed per unit of output. 2. Price standard. The price that should be paid for a specific quantity of input. This indicates what the cost of the quantity standard should be. This is normally expressed per unit of input. : ‘Advantages of using the Standard Cost System . 1, Clerical efficiency - a company that uses standard costs to trace the flow of Costs through its accounting system usually discovers that less clerical time and effort are required than in an actual cost system. 2. Motivation - standards represent a technique of ‘communication of management's expectation of efficiency to workers. 3. Planning — managers can use currently available standard costs to estimate future quantities and costs. 4. Controlling — the contro! begins ‘with the establishment of standards which Provide a basis against which actual costs can be measured so variances may be computed. 5. Decision making - standard cost information availability facilitates many decisions, 6. Performance evaluation ~ summary variance reports focus attention on the operating performance of subordinate managers, allowing top managers to determine when costs were and were not controlled by which managers. Top management can then provide feedback to subordinate managers. Scanned with CamScannerBudgets vs. Standards igets Standards Purpose | Statements of expected costs. “Emphasis Pertains to what costs should be given a certain level of performance. | Emphasizes cost levels that should not be exceeded Emphasize the levels to which costs should be reduced. Coverage Set for all departments in the firm (e.g. sales, administration, manufacturing, etc.) Set only for the production or manufacturing division of the firm. ‘Analysis — When actual data differ from the budget, it may be an indication of either good or bad performance. In short, this is a measure of performance. The nature and cause of the significant variance-are investigated so that necessary corrective actions are taken accordingly. In short, it imposes responsibility. IMPORTANT NOTE: Standard costs are predetermined, attainable unit costs. Standard cost systems isolate deviations (variances) of actual from expected costs. One advantage of standard costs is that they facilitate flexible budgeting. Accordingly, standard and budgeted costs should not differ when standards are currently attainable. However, in practice, budgeted (estimated actual) costs may differ from standard costs when operating conditions are not expected to reflect those anticipated when the standards were developed. IN RE: FLEXIBLE BUDGETS. A standard cost is an estimate of what a cost should be under normal operating conditions based on accounting and engineering studies. Comparing actual and standard costs permits an evaluation of the effectiveness of managerial performance. Because of the impact of fixed costs in most businesses, a standard costing system is usually not effective unless the company also-has a flexible bud bu mn Setting standards 1. Material Standards — In developing material standards, you have to identify and list the specific direct material components used to manufacture the product. Four things must be known about the materials inputs: ‘© - Type of material needed; © Quality (grade) of material needed; * Quantity of material needed; and * Price per unit of material (must be based on level of quality specified). When all quantity and price information is available, component quantities are multiplied by unit prices to obtain the total cost of each component. These totals are summed to determine the total standard material cost of one unit of product. 2. Labor Standards — the development of labor standards requires the same basic procedures as those under for materials. Each production operation performed by workers or by machinery should be identified. When the time and rate information are available, job task times are multiplied by wage rates to generate the total cost of each operation. These totals are summed to obtain the total standard labor cost of one unit of product. Scanned with CamScanner3. Overhead Standards — Overhead should be assigned to separate | cost pools based on the cost drivers, and allocations to products are made using various activity drivers in order to provide the most appropriate costing information. Both actual and standard costs are recorded in a standard cost system. But standard costs, rather than actual costs, are charged to the Raw Material, Work in Process, and Finished Goods Inventory accounts with any differences between actual and standard costs reported as variances. Q: What is the role of TOP MANAGEMENT in the establishment of standard costs for evaluation purposes? A: A standard cost is an estimate of what a cost should be under normal operating conditions based on studies by accountants and engineers. In addition, line management is usually involved in the setting of standard as are quality personnel. Top management would not be involved se cost estimation is a lower level operating activity. Participation by affected employees in all control systems permits all concerned to understand both performance levels desired and the measurement criteria being applied. IN RE: EMPLOYEE MOTIVATION. Setting standards at an ideal level can motivate employees. However, if the standards are too high, employees may get discouraged. If the standards are too low, employees will not be competitive or driven. Setting the correct level of standards is a difficult task, but it can motivate employees when done correctly. Variance analysis Price variance (PV). It represents the difference between the actual price and the standard price of an input, with quantity held constant at the actual amount. We compare the actual costs (AQ * AP) to what we should have paid for the actual quantity of input (AQ * SP). Where AQ = Actual quantity; AP = Actual price and SP = Standard price. * Price Variance = (AQ * SP) — (AQ * AP) * Price variance = AQ * (SP — AP) Quantity variance (QV). We compare the flexible budget (SQ * SP) to what we should have paid for the actual quantity of input (AQ * SP). When calculating for the quantity variance, only the quantity of input changes, while the standard price is held constant. © Quantity variance = (SQ * SP) — (AQ * SP) © Quantity variance = SP * (SQ - AQ) Favorable — When the actual price or quantity amounts are lower than the standard amounts. Unfavorable — if the actual price or quantity amounts are higher than the standard price or quantity amounts. 0 0—hOOorlL SHS Scanned with CamScannerDirect Mate: Is Variance __1. General material variance mode| Point of purchase material variance model [ _AP*AQ L_Purchased __| Purchased BAP TAQ HEN ee | SPS AQ Sma] [Price] i i<——_ Quantit variance ity _— variance_|<— Total Material Variance SP *AQ 3] Price Lvariance_| SP * AQ Used SP *SQ Quantity . >|_ variance |< VARIANCE DEFINITION RESPONSIBILITY Indicates whether the amount paid for . Material PRICE Purchasing VARIANCE aoe was less than or more than standard manager Material Indicates whether the actual quantity used 2 QUANTITY was less than or more than the standard —— VARIANCE quantity for the actual output achieved. The summation of the individual variances or 4. can also be calculated by subtracting the total Total material | srandard cost from the total actual (not N/A applicable in point of purchase material Php0.05 per oz. Required: 1 . Determine the direct mater V 2. Determine the direct materials quanti 3. Answer the first two items assuming t L_ ounces and used only 240,000 ounces. variance model) Exercise 1. Direct materials variances. ABC Company produced and sold 23,400 units. For production, it purchased and used 260,000 ounces of ingredients that costs a total of Php10,400. The standard cost for direct materials is: (1) 10 oz. per unit and (2) ials price variance. Php2,600 F bai ity variance. Php1,300 UF hat ABC Company purchased 260,000 Php2,600 F; Php300 UF Scanned with CamScannerMaterial Price, Mix, and Yield Variances «Mix —any possible combination of material inputs. : + Yield — the quantity of output that results from a specified input. VARIANCE DEFINITION - Measures the monetary effect of substituting a nonstandard mix of materials. The equation is: Material MIX | “actual mix * actual quantity * standard price) ~ (standard mix * variance actual quantity * standard price) The difference between the actual total quantity of input and the : standard total quantity allowed based on output and uses standard Material YIELD | nix and standard prices to determine variance. The equation is: Mlle (standard mix * actual quantity * standard price) — (standard mix : * standard quantity * standard price). See Direct Labor Variance [ ‘AR * AH SR * AH ‘SR * SH Rate Efficiency variance I< > variance 5 Total Labor Variance VARIANCE DEFINITION The difference between the actual wages paid to labor for the period and the standard cost of actual hours worked, Labor efficiency | Indicates whether the amount of time worked was less than or variance more than the standard quantity for the actual output. The summation of the individual variances or can also be Total labor variance | calculated by subtracting the total standard cost from the total ~ | actual cost. J Labor rate variance Exercise 2. Direct labor variances. DEF Company produced 25,200 units. Direct labor hours used during production was 2,800 hours and the Company incurred total direct labor cost of Php28,700. The standard rate for labor was Php10 per hour and the standard hours needed to finish one unit was 0.10 hours. Required: Determine the following: 1. The direct labor rate variance (same as price variance). Php700 UF 2. The direct labor efficiency variance (same as quantity variance). Php2,800 UF Scanned with CamScannerLabor Rate, Mix, and Yield Variances + Mix~ any possible combination of | i ield — i labor + Yield the quantity of output that resuts fers g Specified i input. [ VARIANCE DEFINITION Presents the financi Proportionate amount of higher ort eth changing the Production. The equation is: lower paid workers in lal effect as Labor MIX variance ‘actual mix * ( x * actual hours * standard rate) ~ (standard mix * actual hours * standard rate) Shows the monetary impact of usin 19 More or fewer total Labor YIELD | than the standard allowed. The equation is: fel hous variance (standard mix * actual hours * standard rate) — (standard mix * standard hours * standard rate) A Factory Overhead Variance VARIABLE MANUFACTURING OVERHEAD VARIANCES : Note that manufacturing overhead costs cannot be traced directly to specific units; they must be applied to products using a predetermined overhead rate and an allocation base (cost driver) such as direct labor hours. The standard overhead rates are estimated before the accounting period begins based on budgeted costs and budgeted levels of the overhead cost drivers. Overhead is then applied to specific units during the period by multiplying the budgeted (standard) rate by the standard quantity of the cost driver. Actual VOH Budgeted VOH ; Applied VOH AR * AH SR* AH SR * SH Spending variance Efiency L_____sJ Total VOH Variance VARIA IITION = Par Tene between total actual variable overhead and the budgeted amount of variable ‘overhead based on actual hours; it is component price and volume differences. caused oad vath price differences: can occur because of ae . cover time, changes in VOH prices have not been included Se it indard rate; , . Associ sociated with quantity differences: can be caused by waste or shrinkage of production inputs (such as indirect materia igeted variable overhead based on i between bud I VOH efficiency ramen viable overhead applied based on standard variance hours allowed for the production achieved. Scanned with CamScannerTotal VOH "The difference between actual variable overhead costs incurred for | ah e the period and standard variable ‘overhead cost applied to the l ee period’s actual production or service output. Exercise 3. Variable manufacturing overhead variance. GHI Company produced 36,000 units. Direct labor hours totaled 4,000 hours to produce the units. Actual variable overhead costs amounted to Php3,600. The variable manufacturing overhead is applied at Php1.00 per direct labor hour and the standard number of hours to produce one unit is 0.10 hours. Required: Determine the following: 1. The variable overhead spending variance. Php400F 2. The variable overhead efficiency variance. Php400UF Exercise 4. Comprehensive. Bianca Company produces a single product. The standard cost card for the product follows: Direct materials (4 yards @ Php6 per yard) Php24 Direct labor (1.80 hours @ Php11 per hour) 19.80 Variable manufacturing overhead (1.80 hours @ Php5.00 per hour) 9.00 During a recent period, the company produced 1,800 units. Various costs associated with the production of these units are given below: Direct materials purchased (8,000 yards) Php46,400 Direct materials used in production 7,500 yards Direct labor cost incurred (2,940 hours) Php28,560 Variable manufacturing overhead cost incurred 15,120 Required: Determine all related variances. DM Price variance. | 2. DM Quantity var. | 3. Labor rate variance. Php1,600 F. Php1,800 UF Php3,780 F 4. Labor efficiency variance. [5. VOH rate variance 6. OH efficiency variance Php3,300 F Php420 UF Php1,500 F. FIXED MANUFACTURING OVERHEAD VARIANCES, ‘Actual FOH Budgeted FOH Saaderd Spending | Volume >|_variance_|< >|_variance_|< |_________s [Total FOH Variance ek ——____ VARIANCE DEFINITION FOH —— spénding | The difference between the total actual d variance budgeted fhead overhead, actual fixed overhead ani The difference between budgeted and applied fix is is also known as the nonsontrllabla, varianeg because managers have the least influence and contro! in the short run. 1, especially in Volume variance Scanned with CamScannerThe difference between actual ed sts irred | ; fixed overhead costs incurred and | FOH variance | standard fixed " | Total : ie fx Overhead cost applied to the period's actual [Exercise 5. FOH variances. MM Corporation has the standard oF ir : | machine i a 2 PRe30 rate per hour to produce 1 unit, The ed 2 ng 13 5 Fours a rate was develo using a capacity of 6,000 units 7 ray | occur evenly throughout the year. See For one month, the Company produced 525 units. Actual fixed o1 i | amounted to Php22,800 for 800 hours of machine time. salad aed altas | Required: Determine all related variances, 1. Determine the FOH spending variance. Php300 UF 2. Determine the FOH volume variance. Php1,125 F TOTAL OVERHEAD VARIANCES + Qne-way variance analysis ‘Actual OH ‘Applied OH Actual FOH Standard FOH + E + Actual VOH (VOH rate * Standard a "> | Total Overhead Variance co Total overhead variance = Actual overhead — Applied overhead * Two-way variance analysis Actual OH Budgeted OH Applied OH | Adjusted for SH Actual FOH Budgeted FOH Standard FOH : + + + HH rate * Actual VOH (VOH rate * Standard Sandard .__hours) a hours) Ly Budget variance (or Controllable Ly Volume Variance) variance _ {© © Budget (or controllable) variance = Actual overhead - Budgeted overhead adjusted for standard hours © Volume (or non-controllable) variance = Budgeted overhead adjusted for standard hours — Applied overhead Scanned with CamScanner+ Three: way variance analysis reo ¢ A Applied OH | | BA AH Budgeted OH ‘Actual OH era ene “Budaeted FOH _ | Budgeted FOH | | Budgeted FOH oman FOH | + e (VOH rate* | | i oH (VOH rate * | (VOH rate * Standard fae bomale Actual hours) | | hours) mi | ‘Spending ] Efficiency Volume >| variance |S —>|_ variance _/€ >| variance |< o OH Spending variance = Actual overhead — Budgeted overhead based on actual input measure © OH Efficiency variance = Budgeted overhead (actual) - Budgeted overhead (standard) © OH Volume variance = Budgeted OH (standard) - Applied overhead nal © VOH spending variance = Actual VOH ~ (VOH rate * AQ) 2 VOH efficiency variance = (VOH rate * AQ) - (VOH rate * SQ) © FOH spending variance = Actual FOH - Budgeted FOH © Volume variance = Budgeted FOH - (FOH rate * SQ) Exercise 6. Comprehensive. ABC Company has the following standards for one unit of product: Direct material: 96 pounds * Php7.20 Php691.20 Direct labor: 3.6 hours * Php20 72 Variable overhead: 1.5 hours of machine time * Php60_ 90 Fixed overhead: 1.5 hours of machine time * Php36, 54 The predetermined overhead rates were developed using a Capacity of 7,200 units per year. Production is assumed to occur evenly throughout the year. eae July 2019, the company produced 630 units. Actual data for the month is as Ws: Direct material purchased: 64,000 pounds @ Php7.10 Direct material used: 60,600 pounds (all from July Purchases) Total labor cost: Php29,000 for 1,800 hours Variable overhead incurred: Php52,500 for 960 hours of Machine time Fixed overhead incurred: Php27,300 for 960 hours of machine time Required: 1. Direct material variances (price and quantity variances). Php6,400 F; Php864 UF 2. Labor variances (rate and efficiency variances). Php7,000 F; Php9,360 F 3. VOH variances (spending and efficiency variances). Php5,100 F; Php900 UF 4, FOH variances (spending and volume variances). Php5,100 F; Php1,620 F 5, Present total overhead variance analysis using ‘ne-, two-, and three- way variance approaches. ~END- Scanned with CamScanner