Chapter 22

Standard Costing
and
Variance Analysis

Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State Universit...
Learning Objectives
1. Define standard costs and describe
how managers use standard costs in
the management cycle.
2. Expl...
Learning Objectives (cont’d)
4. Compute and analyze direct materials
variances.
5. Compute and analyze direct labor
varian...
Standard Costing
• Objective 1
– Define standard costs and describe how
managers use standard costs in the
management cycl...
Standard Costing
… is a method of cost control
that includes a measure of actual
performance and a measure of the
differen...
Standard Costs
• Realistic estimates of costs
– Based on analysis of both past and
projected operating costs and condition...
Standard Costs (cont’d)
• Based on
– Past costs
– Engineering estimates
– Forecasted demand
– Worker input
– Time and moti...
Standard Costing
• How the standard costing method
differs from the normal and actual
costing methods
Product Cost
Element...
Standard Costs and the Management Cycle

• Planning
– Managers use standard costs to
• Develop budgets
– Direct materials
...
Standard Costs and the Management Cycle
(cont’d)

• Executing
– Managers use standard costs to
• Apply dollar, time, and q...
Standard Costs and the Management Cycle
(cont’d)

• Reviewing
– Managers compare standard and actual
costs
• Compute varia...
Standard Costs and the Management Cycle
(cont’d)

• Reporting
– Managers use standard costs to report on
• Operations
• Ma...
Standard
Costing,
Variance
Analysis,
and the
Management
Cycle

22–13
The Relevance of Standard Costing in
Today's Business Environment
• Manufacturing companies
– Increased automation
• Signi...
Discussion
Q. What is the main difference between
the standard costing and normal
costing methods?
A. The standard costing...
Computing Standard Costs
• Objective 2
– Explain how standard costs are developed
and compute a standard unit cost

Copyri...
Computing Standard Costs
• Fully integrated standard costing system
– Uses standard costing for all elements of product
co...
Computing Standard Costs (cont’d)
• Six elements of a standard unit cost for
a manufactured product
1. Price standard for ...
Standard Direct Materials Cost
… is found by multiplying the price
standard for direct materials by the
quantity standard ...
Standard Direct Materials Cost (cont’d)
• Direct materials price standard
– Careful estimate of the cost of a specific
dir...
Standard Direct Materials Cost (cont’d)
• Direct materials quantity standard
– Estimate of the amount of direct materials ...
Standard Direct Labor Cost
… for a product, task, or job
is calculated by multiplying
the standard wage for direct labor b...
Standard Direct Labor Cost (cont’d)
• Direct labor rate standard
– Hourly direct labor rate expected to prevail
during the...
Standard Direct Labor Cost (cont’d)
• Direct labor time standard
– Expected time required for each department,
machine, or...
Standard Manufacturing Overhead Cost
… is the sum of the estimates of variable
and fixed overhead costs in the next
accoun...
Standard Manufacturing Overhead Cost
(cont’d)

• Standard variable overhead rate
– Computed by dividing the total budgeted...
Standard Manufacturing Overhead Cost
(cont’d)

• Standard fixed overhead rate
– Computed by dividing the total budgeted
fi...
Total Standard Unit Cost
Remember When,
Inc., recently
updated the
standards for its
line of watches

Compute the total
st...
Discussion
Q. Why are the variable and fixed
components for the standard
manufacturing overhead cost
computed separately?
...
Variance Analysis
• Objective 3
– Prepare a flexible budget and describe
how variance analysis is used to control
costs

C...
Variance Analysis
… is the process of computing the
differences between standard costs and
actual costs and identifying th...
The Role of Flexible Budgets in Variance
Analysis

• Accuracy of variance analysis depends
greatly on the type of budget m...
The Role of Flexible Budgets in Variance
Analysis (cont’d)

• Static budget
– Also called fixed budget
– Forecasts revenue...
Performance Report Using Data from a Static
Budget

Copyright © Houghton Mifflin Company. All rights reserved.

22–34
The Role of Flexible Budgets in Variance
Analysis (cont’d)

• Flexible budget
– Also called variable budget
– Summary of e...
The Role of Flexible Budgets in Variance
Analysis (cont’d)

• Flexible budget formula
– An equation that determines the ex...
Flexible Budget for Evaluation of Overall
Performance

Copyright © Houghton Mifflin Company. All rights reserved.

22–37
The Role of Flexible Budgets in Variance
Analysis (cont’d)
• The flexible budget formula for Remember
When, Inc. is
Total ...
Performance Report Using Data from a
Flexible Budget

Copyright © Houghton Mifflin Company. All rights reserved.

22–39
Using Variance Analysis to Control Costs
Step 1

Compute variance

Is the variance
significant?

No

No corrective
action ...
Using Variance Analysis to Control Costs
(cont’d)

• Computing the amount of a variance is
important
– But, this does not ...
Discussion
Q. What is the flexible budget formula?
A. It is an equation used to determine
expected, or budgeted cost for a...
Computing and Analyzing Direct Materials
Variances

• Objective 4
– Compute and analyze direct materials
variances

Copyri...
Computing and Analyzing Direct Materials
Variances

• To control operations, managers
compute and analyze variances for
– ...
Computing Direct Materials Variances
• Total direct materials cost variance
– Difference between the standard cost and
act...
Computing Direct Materials Variances
Cambria Company makes leather bags. Each bag should use 4 feet of
leather (standard q...
Computing Direct Materials Variances
(cont’d)

• Total direct materials cost variance
must be broken into two parts to fin...
Computing Direct Materials Variances
(cont’d)
• Direct materials price variance
– Difference between the standard price an...
Computing Direct Materials Variances
(cont’d)
• Direct materials quantity variance
– Difference between the standard quant...
Computing Direct Materials Variances
(cont’d)

• Test calculations of variances
– If correct, the net of the direct materi...
Diagram of Direct Materials Variance Analysis

Copyright © Houghton Mifflin Company. All rights reserved.

22–51
Analyzing and Correcting Direct Materials
Variances
• Company had been experiencing direct
materials price variances and q...
Discussion
Q. What is the direct materials price
variance?
A. It is the difference between the standard
price and the actu...
Computing and Analyzing Direct Labor
Variances

• Objective 5
– Compute and analyze direct labor
variances

Copyright © Ho...
Computing Direct Labor Variances
• Total direct labor cost variance
– Difference between the standard direct
labor cost fo...
Computing Direct Labor Variances (cont’d)
At Cambria Company, each leather bag requires 2.4 standard direct
labor hours, a...
Computing Direct Labor Variances (cont’d)

• Total direct labor cost variance must be
broken onto two parts to find the ca...
Computing Direct Labor Variances (cont’d)
• Direct labor rate variance
– Difference between the standard direct labor rate...
Computing Direct Labor Variances (cont’d)
• Direct labor efficiency variance
– Difference between the standard direct labo...
Computing Direct Labor Variances (cont’d)

• Test calculations of variances
– If correct, the net of the direct labor rate...
Diagram of
Direct Labor
Variance
Analysis

22–61
Analyzing and Correcting Direct Labor
Variances
• Managers analyzed
– Employee time cards
• An assembly worker who had fal...
Discussion
Q. What is the direct labor efficiency
variance?
A. The direct labor efficiency variance is the
difference betw...
Computing and Analyzing Manufacturing
Overhead Variances

• Objective 6
– Compute and analyze manufacturing
overhead varia...
Computing and Analyzing Manufacturing
Overhead Variances
• Controlling variable and fixed overhead costs
is more difficult...
Using a Flexible Budget to Analyze
Manufacturing Overhead Variances

• Cambria Company’s managers use a
flexible budget to...
Flexible
Budget for
Evaluation of
Manufacturing
Overhead
Costs

22–67
Using a Flexible Budget to Analyze
Manufacturing Overhead Variances
• Flexible budget formula
Total Budgeted OH Costs = (V...
Computing Manufacturing Overhead
Variances

• Total manufacturing overhead variance
– Difference between actual overhead c...
Computing Manufacturing Overhead
Variances (cont’d)
For Cambria Company, the standard variable overhead rate is $5.75
per ...
Computing Manufacturing Overhead
Variances (cont’d)
For Cambria Company, the standard variable overhead rate is $5.75
per ...
Variable Overhead Variance
• Total variable overhead variance
– Difference between actual variable
overhead costs and the ...
Variable Overhead Variances (cont’d)
At Cambria Company, each leather bag requires 2.4 standard labor
hours and the variab...
Diagram of
Variable
Overhead
Variance
Analysis

22–74
Variable Overhead Variances (cont’d)
• Total variable overhead cost variance
must be broken into two parts to find
the cau...
Variable Overhead Variances (cont’d)
• Variable overhead spending variance
– Difference between the budgeted variable
over...
Variable Overhead Variances (cont’d)
• Variable overhead efficiency variance
– Difference between the standard direct
labo...
Variable Overhead Variances (cont’d)
• Compute standard hours allowed
Standard Hours Allowed = Good Units Produced × Stand...
Variable Overhead Variances (cont’d)
• Test calculations of variances
– If correct, the net of the variable overhead
spend...
Fixed Overhead Variances
• Total fixed overhead variance
– Difference between actual fixed overhead
costs and the standard...
Diagram of
Fixed
Overhead
Variance
Analysis

22–81
Fixed Overhead Variances (cont’d)
At Cambria Company, each leather bag requires 2.4 standard direct
labor hours and the st...
Fixed Overhead Variances (cont’d)
• Total fixed overhead cost variance must
be broken into two parts to find the
cause of ...
Fixed Overhead Variances (cont’d)
• Fixed overhead budget variance
– Difference between the budgeted and
actual fixed over...
Fixed Overhead Variances (cont’d)
• Fixed overhead volume variance
– Difference between budgeted fixed
overhead costs and ...
Fixed Overhead Variances (cont’d)
• A volume variance will occur if more or less
than normal capacity is used
– Fixed over...
Summary of Manufacturing Overhead
Variances

Variable overhead spending variance
Variable overhead efficiency variance
Fix...
Analyzing and Correcting Manufacturing
Overhead Variances

Variance
Variable overhead
spending variance
Variable overhead
...
Discussion
Q. What four variances are used to
analyze the total manufacturing
overhead variance?
A. Variable overhead spen...
Using Cost Variances to Evaluate Managers’
Performance

• Objective 7
– Explain how variances are used to
evaluate manager...
Using Cost Variances to Evaluate Managers’
Performance

• The effectiveness and fairness of a
manager's performance evalua...
Using Cost Variances to Evaluate Managers’
Performance (cont’d)
• Procedures that should be specified for
managers
– Prepa...
Using Cost Variances to Evaluate Managers’
Performance (cont’d)

• Variance analysis
– Provides detailed data about differ...
Using Cost Variances to Evaluate Managers’
Performance (cont’d)
• Effective managerial performance reports
based on standa...
Using Cost Variances to Evaluate Managers’
Performance (cont’d)

• Managerial performance reports should
– Summarize all c...
Using Cost Variances to Evaluate Managers’
Performance (cont’d)

• The occurrence of a variance does not
indicate poor per...
Discussion
Q. What items should be included in an
effective managerial performance
report?
A. Summarization of all cost da...
Time for Review
1. Define standard costs and describe
how managers use standard costs in
the management cycle
2. Explain h...
And Finally…
4. Compute and analyze direct materials
variances
5. Compute and analyze direct labor
variances
6. Compute an...
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  1. 1. Chapter 22 Standard Costing and Variance Analysis Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University
  2. 2. Learning Objectives 1. Define standard costs and describe how managers use standard costs in the management cycle. 2. Explain how standard costs are developed and compute a standard unit cost. 3. Prepare a flexible budget and describe how variance analysis is used to control costs. Copyright © Houghton Mifflin Company. All rights reserved. 22–2
  3. 3. Learning Objectives (cont’d) 4. Compute and analyze direct materials variances. 5. Compute and analyze direct labor variances. 6. Compute and analyze manufacturing overhead variances. 7. Explain how variances are used to evaluate managers’ performance. Copyright © Houghton Mifflin Company. All rights reserved. 22–3
  4. 4. Standard Costing • Objective 1 – Define standard costs and describe how managers use standard costs in the management cycle Copyright © Houghton Mifflin Company. All rights reserved. 22–4
  5. 5. Standard Costing … is a method of cost control that includes a measure of actual performance and a measure of the difference, or variance, between standard and actual performance Copyright © Houghton Mifflin Company. All rights reserved. 22–5
  6. 6. Standard Costs • Realistic estimates of costs – Based on analysis of both past and projected operating costs and conditions • Provide a predetermined performance level for the standard costing method • Usually stated in terms of cost per unit Copyright © Houghton Mifflin Company. All rights reserved. 22–6
  7. 7. Standard Costs (cont’d) • Based on – Past costs – Engineering estimates – Forecasted demand – Worker input – Time and motion studies – Type and quality of direct materials Copyright © Houghton Mifflin Company. All rights reserved. 22–7
  8. 8. Standard Costing • How the standard costing method differs from the normal and actual costing methods Product Cost Elements Direct Materials Direct Labor Manufacturing Overhead Standard Costing Estimated costs Estimated costs Estimated costs Copyright © Houghton Mifflin Company. All rights reserved. Normal Costing Actual costs Actual costs Estimated costs Actual Costing Actual costs Actual costs Actual costs 22–8
  9. 9. Standard Costs and the Management Cycle • Planning – Managers use standard costs to • Develop budgets – Direct materials – Direct labor – Variable manufacturing overhead • Establish goals for product costing Copyright © Houghton Mifflin Company. All rights reserved. 22–9
  10. 10. Standard Costs and the Management Cycle (cont’d) • Executing – Managers use standard costs to • Apply dollar, time, and quality standards to work • Collect actual cost data Copyright © Houghton Mifflin Company. All rights reserved. 22–10
  11. 11. Standard Costs and the Management Cycle (cont’d) • Reviewing – Managers compare standard and actual costs • Compute variances – Provide measures of performance that can be used to control costs and evaluate managers – Analyze significant variances to determine cause » Unfavorable variances may reveal operating problems that require correcting » Favorable variances may indicate favorable practices that should be implemented elsewhere Copyright © Houghton Mifflin Company. All rights reserved. 22–11
  12. 12. Standard Costs and the Management Cycle (cont’d) • Reporting – Managers use standard costs to report on • Operations • Managers’ performance Copyright © Houghton Mifflin Company. All rights reserved. 22–12
  13. 13. Standard Costing, Variance Analysis, and the Management Cycle 22–13
  14. 14. The Relevance of Standard Costing in Today's Business Environment • Manufacturing companies – Increased automation • Significant decrease in direct labor cost – Corresponding decline in importance of labor-related standard costs and variances • Many companies now apply standard costing only to direct materials and manufacturing overhead • Service organizations – Use standard costing for direct labor and service overhead costs Copyright © Houghton Mifflin Company. All rights reserved. 22–14
  15. 15. Discussion Q. What is the main difference between the standard costing and normal costing methods? A. The standard costing method uses estimated costs for direct materials and direct labor, whereas the normal costing method uses actual costs for these items The methods are similar in that both use estimated costs for manufacturing overhead Copyright © Houghton Mifflin Company. All rights reserved. 22–15
  16. 16. Computing Standard Costs • Objective 2 – Explain how standard costs are developed and compute a standard unit cost Copyright © Houghton Mifflin Company. All rights reserved. 22–16
  17. 17. Computing Standard Costs • Fully integrated standard costing system – Uses standard costing for all elements of product cost • Direct materials • Direct labor • Manufacturing overhead – Inventory accounts and Cost of Goods Sold account • Maintained and reported in terms of standard costs • Standard unit costs used to compute account balances • Actual costs recorded separately – Actual and standard costs can then be compared Copyright © Houghton Mifflin Company. All rights reserved. 22–17
  18. 18. Computing Standard Costs (cont’d) • Six elements of a standard unit cost for a manufactured product 1. Price standard for direct materials 2. Quantity standard for direct materials 3. Standard for direct labor rate 4. Standard for direct labor time 5. Standard for variable overhead rate 6. Standard for fixed overhead rate Copyright © Houghton Mifflin Company. All rights reserved. 22–18
  19. 19. Standard Direct Materials Cost … is found by multiplying the price standard for direct materials by the quantity standard for direct materials Standard Direct Materials Cost = Direct Materials Price Standard Copyright © Houghton Mifflin Company. All rights reserved. x Direct Materials Quantity Standard 22–19
  20. 20. Standard Direct Materials Cost (cont’d) • Direct materials price standard – Careful estimate of the cost of a specific direct material in the next accounting period – Developed by purchasing agent or purchasing department • Takes into account – All possible price increases – Changes in available quantities – New sources of supply Copyright © Houghton Mifflin Company. All rights reserved. 22–20
  21. 21. Standard Direct Materials Cost (cont’d) • Direct materials quantity standard – Estimate of the amount of direct materials that will be used in the accounting period • Includes scrap and waste – Influenced by • • • • Product engineering specifications Quality of direct materials Age and productivity of machinery Quality and experience of work force – Established and monitored by • Production managers • Management accountants • Others – Engineers, purchasing agents, machine operators Copyright © Houghton Mifflin Company. All rights reserved. 22–21
  22. 22. Standard Direct Labor Cost … for a product, task, or job is calculated by multiplying the standard wage for direct labor by the standard hours of direct labor Standard Direct Labor Cost = Direct Labor Rate Standard Copyright © Houghton Mifflin Company. All rights reserved. x Direct Labor Time Standard 22–22
  23. 23. Standard Direct Labor Cost (cont’d) • Direct labor rate standard – Hourly direct labor rate expected to prevail during the next accounting period • For each function or job classification – Average standard rate is developed for each task • Standard rate is used even if worker is paid more or less than the standard rate – Easy to establish • Rates are set by labor unions or defined by the company Copyright © Houghton Mifflin Company. All rights reserved. 22–23
  24. 24. Standard Direct Labor Cost (cont’d) • Direct labor time standard – Expected time required for each department, machine, or process to complete the production of one unit or one batch of output – Developed using • Current time and motion studies of workers and machines • Records of past performance – Should be revised when • Machinery is replaced • Quality of work force changes Copyright © Houghton Mifflin Company. All rights reserved. 22–24
  25. 25. Standard Manufacturing Overhead Cost … is the sum of the estimates of variable and fixed overhead costs in the next accounting period • Two parts – Variable costs and fixed costs • Compute separately because their cost behavior differs Copyright © Houghton Mifflin Company. All rights reserved. 22–25
  26. 26. Standard Manufacturing Overhead Cost (cont’d) • Standard variable overhead rate – Computed by dividing the total budgeted variable overhead costs by an expression of capacity, such as number of standard direct labor hours or standard machine hours Standard Variable Overhead Rate = Total Budgeted Variable Overhead Costs Expected Number of Standard Machine Hours Copyright © Houghton Mifflin Company. All rights reserved. 22–26
  27. 27. Standard Manufacturing Overhead Cost (cont’d) • Standard fixed overhead rate – Computed by dividing the total budgeted fixed overhead costs by an expression of capacity, usually normal capacity in terms of standard hours or units • Denominator expressed in same terms as the variable overhead rate Standard Fixed Overhead Rate = Total Budgeted Fixed Overhead Costs Normal Capacity in Terms of Standard Machine Hours Normal capacity is the level of operating capacity needed to meet expected sales demand Its use ensures that all fixed OH* costs have been applied to units produced by the time normal capacity is reached *Overhead Copyright © Houghton Mifflin Company. All rights reserved. 22–27
  28. 28. Total Standard Unit Cost Remember When, Inc., recently updated the standards for its line of watches Compute the total standard cost of one watch Direct materials price standards Casing materials Movement mechanism Direct materials quantity standards Casing materials Movement mechanism Direct labor time standards Case Stamping Department Watch Assembly Department Direct labor rate standards Case Stamping Department Watch Assembly Department Standard manufacturing overhead rates Standard variable overhead rate Standard fixed overhead rate $9.20 per square foot $2.17 each .025 square foot per watch 1 per watch .01 hour per watch .05 hour per watch $8.00 per hour $10.20 per hour $12.00 per direct labor hour $9.00 per direct labor hour Direct materials costs Casing ($9.20 per sq.ft. x .025 sq.ft.) One movement mechanism Direct labor costs Case Stamping Dept. ($8.00 per hour x .01 hour per watch) Watch Assembly Dept. (10.20 per hour x .05 hour per watch) Variable overhead ($12.00 per hour x .06 hour per watch) Total standard variable cost of one watch Fixed overhead ($9.00 per hour x .06 hour per watch) Total standard cost of one watch Copyright © Houghton Mifflin Company. All rights reserved. $ .23 2.17 .08 .51 .72 $3.71 .54 $4.25 22–28
  29. 29. Discussion Q. Why are the variable and fixed components for the standard manufacturing overhead cost computed separately? A. Variable costs and fixed costs are computed separately because their cost behavior differs Copyright © Houghton Mifflin Company. All rights reserved. 22–29
  30. 30. Variance Analysis • Objective 3 – Prepare a flexible budget and describe how variance analysis is used to control costs Copyright © Houghton Mifflin Company. All rights reserved. 22–30
  31. 31. Variance Analysis … is the process of computing the differences between standard costs and actual costs and identifying the causes of those differences • Managers use – Flexible budgets to improve variance analysis – Variance analysis to control costs Copyright © Houghton Mifflin Company. All rights reserved. 22–31
  32. 32. The Role of Flexible Budgets in Variance Analysis • Accuracy of variance analysis depends greatly on the type of budget managers use when comparing variances – Static budget – Flexible budget Copyright © Houghton Mifflin Company. All rights reserved. 22–32
  33. 33. The Role of Flexible Budgets in Variance Analysis (cont’d) • Static budget – Also called fixed budget – Forecasts revenues and expenses for just one level of sales and just one level of output • Does not allow for changes in output level – If actual output differs from budgeted output, a variance between actual and budgeted amounts will occur » Cannot judge performance accurately Copyright © Houghton Mifflin Company. All rights reserved. 22–33
  34. 34. Performance Report Using Data from a Static Budget Copyright © Houghton Mifflin Company. All rights reserved. 22–34
  35. 35. The Role of Flexible Budgets in Variance Analysis (cont’d) • Flexible budget – Also called variable budget – Summary of expected costs for a range of activity levels • Provides forecasted data that can be adjusted for changes in output level – Used primarily as a cost control tool in evaluating performance Copyright © Houghton Mifflin Company. All rights reserved. 22–35
  36. 36. The Role of Flexible Budgets in Variance Analysis (cont’d) • Flexible budget formula – An equation that determines the expected, or budgeted, cost for any level of output • Includes – Per unit amount for variable costs – Total amount for fixed costs Total Budgeted Costs = (Variable Cost per Unit × No. of Units Produced) + Budgeted Fixed Costs Copyright © Houghton Mifflin Company. All rights reserved. 22–36
  37. 37. Flexible Budget for Evaluation of Overall Performance Copyright © Houghton Mifflin Company. All rights reserved. 22–37
  38. 38. The Role of Flexible Budgets in Variance Analysis (cont’d) • The flexible budget formula for Remember When, Inc. is Total Budgeted Costs = ($3.71 × No. of Units Produced) + $9,450 • The company produced 19,100 units during 20x5 Total Budgeted Costs = ($3.71 × 19,100) + $9,450 = $70,861 + $9,450 = $80,311 Copyright © Houghton Mifflin Company. All rights reserved. 22–38
  39. 39. Performance Report Using Data from a Flexible Budget Copyright © Houghton Mifflin Company. All rights reserved. 22–39
  40. 40. Using Variance Analysis to Control Costs Step 1 Compute variance Is the variance significant? No No corrective action needed Yes Step 2 Analyze variance to determine its cause Step 3 Select performance measures to correct the problem Step 4 Take corrective action Copyright © Houghton Mifflin Company. All rights reserved. 22–40
  41. 41. Using Variance Analysis to Control Costs (cont’d) • Computing the amount of a variance is important – But, this does not prevent the variance from reoccurring – Must determine its cause • Select performance measures that will help track the problem • Must then find the best solution Copyright © Houghton Mifflin Company. All rights reserved. 22–41
  42. 42. Discussion Q. What is the flexible budget formula? A. It is an equation used to determine expected, or budgeted cost for any level of output Total Budgeted Costs = (Variable Cost per Unit × No. of Units Produced) + Budgeted Fixed Costs Copyright © Houghton Mifflin Company. All rights reserved. 22–42
  43. 43. Computing and Analyzing Direct Materials Variances • Objective 4 – Compute and analyze direct materials variances Copyright © Houghton Mifflin Company. All rights reserved. 22–43
  44. 44. Computing and Analyzing Direct Materials Variances • To control operations, managers compute and analyze variances for – Whole cost categories • Such as total direct materials costs – Elements of those categories • Such as the price and quantity of each direct material The more detailed the analysis of a variance is, the more effective managers will be in controlling costs Copyright © Houghton Mifflin Company. All rights reserved. 22–44
  45. 45. Computing Direct Materials Variances • Total direct materials cost variance – Difference between the standard cost and actual cost of direct materials Copyright © Houghton Mifflin Company. All rights reserved. 22–45
  46. 46. Computing Direct Materials Variances Cambria Company makes leather bags. Each bag should use 4 feet of leather (standard quantity), and the standard price of leather is $6.00 per foot. During August, the company purchased 760 feet of leather costing $5.90 per foot and used the leather to produce 180 bags Standard cost Standard price × standard quantity = $6.00 per foot × (180 bags × 4 feet per bag) = $6.00 per foot × 720 = $4,320 Less actual cost Actual price × actual quantity = This is an unfavorable (U) situation $5.90 per foot × 760 = 4,484 Total direct materials cost variance $ 164 (U) Actual cost > standard cost Copyright © Houghton Mifflin Company. All rights reserved. 22–46
  47. 47. Computing Direct Materials Variances (cont’d) • Total direct materials cost variance must be broken into two parts to find the cause of the variance – Direct materials price variance – Direct materials quantity variance Copyright © Houghton Mifflin Company. All rights reserved. 22–47
  48. 48. Computing Direct Materials Variances (cont’d) • Direct materials price variance – Difference between the standard price and the actual price per unit multiplied by the actual quantity purchased – Also called the direct materials spending or rate variance Direct Materials Price Variance = (Standard Price − Actual Price) × Actual Quantity = ($6.00 − $5.90) × 760 feet = $76 (F) Because the company paid less for direct materials than it expected, the variance is favorable (F) Copyright © Houghton Mifflin Company. All rights reserved. 22–48
  49. 49. Computing Direct Materials Variances (cont’d) • Direct materials quantity variance – Difference between the standard quantity and the actual quantity used multiplied by the standard price – Also called the direct materials efficiency or usage variance Direct Materials Quantity Variance = Standard Price × (Standard Quantity Allowed − Actual Quantity) = $6.00 per foot × (720 feet − 760 feet) = $240 (U) Because the company used more for direct materials than it expected, the variance is unfavorable (U) Copyright © Houghton Mifflin Company. All rights reserved. 22–49
  50. 50. Computing Direct Materials Variances (cont’d) • Test calculations of variances – If correct, the net of the direct materials price variance and direct materials quantity variance will equal the total direct materials cost variance Direct materials price variance Direct materials quantity variance Total direct materials cost variance Copyright © Houghton Mifflin Company. All rights reserved. $ 76 (F) 240 (U) $164 (U) 22–50
  51. 51. Diagram of Direct Materials Variance Analysis Copyright © Houghton Mifflin Company. All rights reserved. 22–51
  52. 52. Analyzing and Correcting Direct Materials Variances • Company had been experiencing direct materials price variances and quantity variances for some time • For three months, managers tracked – Purchasing activities • Discovered that the purchasing agent had purchased, without authorization, a lower grade of leather at a reduced price – After analysis, engineers determined the lower grade of leather was not appropriate – Scrap and rework • Discovered that inferior leather was causing the unfavorable quantity variance Copyright © Houghton Mifflin Company. All rights reserved. 22–52
  53. 53. Discussion Q. What is the direct materials price variance? A. It is the difference between the standard price and the actual price per unit multiplied by the actual quantity purchased. It is also called the direct materials spending or rate variance Direct Materials Price Variance = (Standard Price − Actual Price) × Actual Quantity Copyright © Houghton Mifflin Company. All rights reserved. 22–53
  54. 54. Computing and Analyzing Direct Labor Variances • Objective 5 – Compute and analyze direct labor variances Copyright © Houghton Mifflin Company. All rights reserved. 22–54
  55. 55. Computing Direct Labor Variances • Total direct labor cost variance – Difference between the standard direct labor cost for good units produced and actual direct labor costs • Good units are the total units produced less units that are scrapped or need to be reworked Copyright © Houghton Mifflin Company. All rights reserved. 22–55
  56. 56. Computing Direct Labor Variances (cont’d) At Cambria Company, each leather bag requires 2.4 standard direct labor hours, and the standard direct labor rate is $8.50 per hour. During August, 450 direct labor hours were used to make 180 bags at an average pay rate of $9.20 per hour Standard cost Standard rate × standard hours allowed = $8.50 per foot × (180 bags × 2.4 hours per bag) = $8.50 per hour × 432 hours = $3,672 Less actual cost Actual rate × actual hours = $9.20 per hour × 450 hours = 4,140 Total direct labor cost variance $ 468 (U) Actual cost > standard cost Copyright © Houghton Mifflin Company. All rights reserved. 22–56
  57. 57. Computing Direct Labor Variances (cont’d) • Total direct labor cost variance must be broken onto two parts to find the cause of the variance – Direct labor rate variance – Direct labor efficiency variance Copyright © Houghton Mifflin Company. All rights reserved. 22–57
  58. 58. Computing Direct Labor Variances (cont’d) • Direct labor rate variance – Difference between the standard direct labor rate and the actual direct labor rate multiplied by the actual direct labor hours worked – Also called the direct labor spending variance Direct Labor Rate Variance = (Standard Rate − Actual Rate) × Actual Hours = ($8.50 − $9.20) × 450 hours = $315 (U) Because the company paid more per hour for direct labor than it expected, the variance is unfavorable Copyright © Houghton Mifflin Company. All rights reserved. 22–58
  59. 59. Computing Direct Labor Variances (cont’d) • Direct labor efficiency variance – Difference between the standard direct labor hours allowed for good units produced and the actual direct labor hours worked multiplied by the standard direct labor rate – Also called the direct labor quantity or usage variance Direct Labor Efficiency Variance = Standard Rate × (Standard Hours Allowed − Actual Hours) = $8.50 per hour × (432 hours − 450 hours) = $153 (U) Because the company used more direct labor hours than it expected, the variance is unfavorable (U) Copyright © Houghton Mifflin Company. All rights reserved. 22–59
  60. 60. Computing Direct Labor Variances (cont’d) • Test calculations of variances – If correct, the net of the direct labor rate variance and direct labor efficiency variance will equal the total direct labor cost variance Direct labor rate variance Direct labor efficiency variance Total direct labor cost variance Copyright © Houghton Mifflin Company. All rights reserved. $ 315 (U) 153 (U) $468 (U) 22–60
  61. 61. Diagram of Direct Labor Variance Analysis 22–61
  62. 62. Analyzing and Correcting Direct Labor Variances • Managers analyzed – Employee time cards • An assembly worker who had fallen ill was replaced with a machinery operator from another department – Assembly worker is paid $8.50 per hour and the machine operator is paid $9.20 per hour – Machine operator not as skilled as the assembly worker » Temporary situation so no corrective action taken – Materials handling • Parts delivered late on five occasions – Will track delivery time and number of delays for next three months Copyright © Houghton Mifflin Company. All rights reserved. 22–62
  63. 63. Discussion Q. What is the direct labor efficiency variance? A. The direct labor efficiency variance is the difference between the standard direct labor hours allowed for good units produced and the actual direct labor hours worked multiplied by the standard direct labor rate. It is also called the direct labor quantity or usage variance Direct Labor Efficiency Variance = Standard Rate × (Standard Hours Allowed − Actual Hours) Copyright © Houghton Mifflin Company. All rights reserved. 22–63
  64. 64. Computing and Analyzing Manufacturing Overhead Variances • Objective 6 – Compute and analyze manufacturing overhead variances Copyright © Houghton Mifflin Company. All rights reserved. 22–64
  65. 65. Computing and Analyzing Manufacturing Overhead Variances • Controlling variable and fixed overhead costs is more difficult for managers than controlling direct materials and direct labor costs – Responsibility for manufacturing overhead costs is hard to assign • Fixed overhead costs – Unavoidable past costs – Not under the control of any department manager • Variable overhead costs – Some control possible if they can be related to departments or activities Copyright © Houghton Mifflin Company. All rights reserved. 22–65
  66. 66. Using a Flexible Budget to Analyze Manufacturing Overhead Variances • Cambria Company’s managers use a flexible budget to evaluate performance – For manufacturing overhead costs only – Evaluate activity level using direct labor hours • Variable costs vary with the number of direct labor hours worked • Total fixed overhead costs remain constant Copyright © Houghton Mifflin Company. All rights reserved. 22–66
  67. 67. Flexible Budget for Evaluation of Manufacturing Overhead Costs 22–67
  68. 68. Using a Flexible Budget to Analyze Manufacturing Overhead Variances • Flexible budget formula Total Budgeted OH Costs = (Variable Costs per Direct Labor Hour × Number of Direct Labor Hours) + Budgeted Fixed OH Costs • Flexible budget formula when applied to Cambria’s data Total Budgeted OH Costs = ($5.75 × No. of Direct Labor Hours) + $1,300 To find the total monthly budgeted overhead costs, insert direct labor hours into the flexible budget Copyright © Houghton Mifflin Company. All rights reserved. 22–68
  69. 69. Computing Manufacturing Overhead Variances • Total manufacturing overhead variance – Difference between actual overhead costs and standard overhead costs • Standard overhead costs are applied to production using a standard overhead rate – Standard overhead rate has two parts » Variable » Fixed Copyright © Houghton Mifflin Company. All rights reserved. 22–69
  70. 70. Computing Manufacturing Overhead Variances (cont’d) For Cambria Company, the standard variable overhead rate is $5.75 per direct labor hour (from the flexible budget). Total budgeted overhead is $1,300 by normal capacity, which is 400 direct labor hours. Fixed overhead rate Budgeted fixed overhead ÷ normal capacity = $1,300 ÷ 400 direct labor hours = $3.25 Total standard overhead rate Standard variable overhead rate + standard fixed overhead rate = $5.75 + $3.25 = $9.00 Copyright © Houghton Mifflin Company. All rights reserved. 22–70
  71. 71. Computing Manufacturing Overhead Variances (cont’d) For Cambria Company, the standard variable overhead rate is $5.75 per direct labor hour (from the flexible budget). Total budgeted overhead is $1,300 by normal capacity, which is 400 direct labor hours. Standard OH costs applied to good units produced Total standard OH rate × ( No. good units produced × standard hours allowed) = $9.00 per direct labor hour × (180 bags × 2.4 hours per bag) = $3,888 4,100 Less actual overhead costs Total manufacturing overhead variance $ 212 (U) Actual cost > standard cost This amount can be divided into variable overhead variances and fixed overhead variances Copyright © Houghton Mifflin Company. All rights reserved. 22–71
  72. 72. Variable Overhead Variance • Total variable overhead variance – Difference between actual variable overhead costs and the standard variable overhead costs that are applied to good units produced using the standard variable rate Copyright © Houghton Mifflin Company. All rights reserved. 22–72
  73. 73. Variable Overhead Variances (cont’d) At Cambria Company, each leather bag requires 2.4 standard labor hours and the variable overhead rate is $5.75 per direct labor hour. During August, the company incurred $2,500 of variable overhead costs Overhead applied to good units produced Standard variable rate × standard direct labor hours allowed = $5.75 per hour × (180 bags × 2.4 hours per bag) = Less actual cost $5.75 per hour × 432 hours = $2,484 2,500 Total variable overhead cost variance $ 16 (U) Actual cost > standard cost Copyright © Houghton Mifflin Company. All rights reserved. 22–73
  74. 74. Diagram of Variable Overhead Variance Analysis 22–74
  75. 75. Variable Overhead Variances (cont’d) • Total variable overhead cost variance must be broken into two parts to find the cause of the variance – Variable overhead spending variance – Variable overhead efficiency variance Copyright © Houghton Mifflin Company. All rights reserved. 22–75
  76. 76. Variable Overhead Variances (cont’d) • Variable overhead spending variance – Difference between the budgeted variable overhead costs at actual hours and actual variable overhead Variable OH Spending Variance = Budgeted Variable Costs at Actual Hours − Actual Variable Overhead = (Standard Variable Rate × Actual Hours Worked) − Actual Variable OH = ($5.75 × 450 hours) − $2,500 = $87.50 (F) Copyright © Houghton Mifflin Company. All rights reserved. 22–76
  77. 77. Variable Overhead Variances (cont’d) • Variable overhead efficiency variance – Difference between the standard direct labor hours allowed for good units produced and the actual hours worked multiplied by the standard variable overhead rate Variable OH Efficiency Variance = Standard Variable Rate × (Standard Hours Allowed − Actual Hours) Copyright © Houghton Mifflin Company. All rights reserved. 22–77
  78. 78. Variable Overhead Variances (cont’d) • Compute standard hours allowed Standard Hours Allowed = Good Units Produced × Standard Hours per Bag = 180 bags × 2.4 hours per bag = 432 hours • Compute variable overhead efficiency variance Variable OH Efficiency Variance = Standard Variable Rate × (Standard Hours Allowed − Actual Hours) = $5.75 × (432 hours − 450 hours) = $103.50 (U) Copyright © Houghton Mifflin Company. All rights reserved. 22–78
  79. 79. Variable Overhead Variances (cont’d) • Test calculations of variances – If correct, the net of the variable overhead spending variance and variable overhead efficiency variance will equal the total variable overhead cost variance Variable overhead spending variance Variable overhead efficiency variance Total variable overhead cost variance Copyright © Houghton Mifflin Company. All rights reserved. $ 87.50 103.50 $ 16.00 (F) (U) (U) 22–79
  80. 80. Fixed Overhead Variances • Total fixed overhead variance – Difference between actual fixed overhead costs and the standard fixed overhead costs that are applied to good units produced using the standard fixed overhead rate Copyright © Houghton Mifflin Company. All rights reserved. 22–80
  81. 81. Diagram of Fixed Overhead Variance Analysis 22–81
  82. 82. Fixed Overhead Variances (cont’d) At Cambria Company, each leather bag requires 2.4 standard direct labor hours and the standard fixed overhead rate is $3.25 per direct labor hour. During August, the company incurred $1,600 of actual fixed overhead costs Overhead applied to good units produced Standard fixed rate × standard direct labor hours allowed = $3.25 per hour × (180 bags × 2.4 hours per bag) = $3.25 per hour × 432 hours = $1,404 Less actual cost 1,600 Total fixed overhead cost variance Copyright © Houghton Mifflin Company. All rights reserved. $ 196 (U) 22–82
  83. 83. Fixed Overhead Variances (cont’d) • Total fixed overhead cost variance must be broken into two parts to find the cause of the variance – Fixed overhead budget variance – Fixed overhead volume variance Copyright © Houghton Mifflin Company. All rights reserved. 22–83
  84. 84. Fixed Overhead Variances (cont’d) • Fixed overhead budget variance – Difference between the budgeted and actual fixed overhead costs – Also called budgeted fixed overhead variance Fixed OH Budget Variance = Budgeted Fixed Overhead − Actual Fixed Overhead = $1,300 − $1,600 = $300 (U) Copyright © Houghton Mifflin Company. All rights reserved. 22–84
  85. 85. Fixed Overhead Variances (cont’d) • Fixed overhead volume variance – Difference between budgeted fixed overhead costs and manufacturing overhead costs applied to production using the standard fixed overhead rate Standard fixed OH applied for 432 direct labor hours $3.25 per direct labor hour × (180 bags × 2.4 hours per bag) Less total budgeted fixed overhead Total variable overhead cost variance Copyright © Houghton Mifflin Company. All rights reserved. $1,404 1,300 $ 104 (F) 22–85
  86. 86. Fixed Overhead Variances (cont’d) • A volume variance will occur if more or less than normal capacity is used – Fixed overhead volume variance measures the use of existing facilities and capacity – Favorable overhead volume variance • Capacity exceeds the expected amount – Unfavorable overhead volume variance • Company operates at a level below normal capacity – May be in best interest of company during periods of slow sales – Means company is not building up excess inventory Copyright © Houghton Mifflin Company. All rights reserved. 22–86
  87. 87. Summary of Manufacturing Overhead Variances Variable overhead spending variance Variable overhead efficiency variance Fixed overhead budget variance Fixed overhead volume variance Total manufacturing overhead variance Copyright © Houghton Mifflin Company. All rights reserved. $ 87.50 103.50 300.00 104.00 $212.00 (F) (U) (U) (F) (U) 22–87
  88. 88. Analyzing and Correcting Manufacturing Overhead Variances Variance Variable overhead spending variance Variable overhead efficiency variance Fixed overhead budget variance Fixed overhead volume variance Amount Cause Corrective Action $87.50 (F) Savings on purchases No action Inefficiency of machine 103.50 (U) operator who substituted for ill assembly worker Higher than expected factory insurance premiums due to 300.00 (U) increased claims filed by employees Consider feasibility of implementing a program for cross-training employees Overutilization of capacity 104.00 (F) traced to high seasonal demand Copyright © Houghton Mifflin Company. All rights reserved. Study insurance claims filed over a three-month period No action necessary because variance fell within anticipated range 22–88
  89. 89. Discussion Q. What four variances are used to analyze the total manufacturing overhead variance? A. Variable overhead spending variance Variable overhead efficiency variance Fixed overhead budget variance Fixed overhead volume variance Copyright © Houghton Mifflin Company. All rights reserved. 22–89
  90. 90. Using Cost Variances to Evaluate Managers’ Performance • Objective 7 – Explain how variances are used to evaluate managers’ performance Copyright © Houghton Mifflin Company. All rights reserved. 22–90
  91. 91. Using Cost Variances to Evaluate Managers’ Performance • The effectiveness and fairness of a manager's performance evaluation depends on – Human factors – Company policies • Should be based on input from managers and employees • Should specify procedures that managers are to use Copyright © Houghton Mifflin Company. All rights reserved. 22–91
  92. 92. Using Cost Variances to Evaluate Managers’ Performance (cont’d) • Procedures that should be specified for managers – Preparing operational plans – Assigning responsibility for carrying out the operational plans – Communicating operational plans to key personnel – Evaluating performance in each area of responsibility – Identifying causes of significant variances from the operational plan – Taking corrective action to eliminate problems Copyright © Houghton Mifflin Company. All rights reserved. 22–92
  93. 93. Using Cost Variances to Evaluate Managers’ Performance (cont’d) • Variance analysis – Provides detailed data about differences between standard and actual costs • Effective at pinpointing efficient and inefficient operating areas – Basic comparison of budgeted and actual data not as effective Copyright © Houghton Mifflin Company. All rights reserved. 22–93
  94. 94. Using Cost Variances to Evaluate Managers’ Performance (cont’d) • Effective managerial performance reports based on standard costs and related variances should – Identify • Causes of the differences • Personnel involved • Corrective actions taken – Be tailored to the manager’s specific areas of responsibility • Explain clearly and accurately in what way the manager’s department did or did not meet operating expectations Managers should only be held accountable for cost areas under their control Copyright © Houghton Mifflin Company. All rights reserved. 22–94
  95. 95. Using Cost Variances to Evaluate Managers’ Performance (cont’d) • Managerial performance reports should – Summarize all cost data – Include variances for direct materials, direct labor, and manufacturing overhead – Identify • Causes of variances • Corrective actions taken Copyright © Houghton Mifflin Company. All rights reserved. 22–95
  96. 96. Using Cost Variances to Evaluate Managers’ Performance (cont’d) • The occurrence of a variance does not indicate poor performance • If a variance consistently occurs, its cause is not identified, and no corrective action is taken, it may indicate poor performance on the part of the manager Copyright © Houghton Mifflin Company. All rights reserved. 22–96
  97. 97. Discussion Q. What items should be included in an effective managerial performance report? A. Summarization of all cost data Variances for direct materials, direct labor, and manufacturing overhead Identification of the causes of the variances, personnel involved, and any corrective actions taken Copyright © Houghton Mifflin Company. All rights reserved. 22–97
  98. 98. Time for Review 1. Define standard costs and describe how managers use standard costs in the management cycle 2. Explain how standard costs are developed and compute a standard unit cost 3. Prepare a flexible budget and describe how variance analysis is used to control costs Copyright © Houghton Mifflin Company. All rights reserved. 22–98
  99. 99. And Finally… 4. Compute and analyze direct materials variances 5. Compute and analyze direct labor variances 6. Compute and analyze manufacturing overhead variances 7. Explain how variances are used to evaluate managers’ performance Copyright © Houghton Mifflin Company. All rights reserved. 22–99

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