Chapter 7: Standard Costing and Variance Analysis Cost Accounting: Foundations and Evolutions, 8e Kinney ● Raiborn © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Learning Objectives How are material, labor, and overhead standards set? How are material, labor, and overhead variances calculated and recorded? Why are standard cost systems used? 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? © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Standard Cost Systems Manufacturing Service Not-for-Profit Record standard and actual costs in the accounting records © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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 © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Manufacturing Objective Minimize unit cost while achieving certain quality specifications. Input Resources Output Quality © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Material Standards Materials used Types Quantity Quality Price From Product specifications, observation, inquiry Bill of materials Balance cost, quality, and projected sales price Standard Material = Cost Unit Purchase Price * quantity © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Labor Standards Labor used Types From Production, setup, cleanup, and rework Quantity Cost Include wages, payroll taxes, and fringe benefits Standard Labor = Cost Industrial engineering studies including methods-time measurement (MTM), time and motion studies, historical data Operations flow document Hours * Wage Rate © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Overhead Standards Variable and fixed manufacturing overhead Estimated level of activity Estimated costs Predetermined factory overhead application rates © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Standard Cost Card For one unit of output (a bike) Standard Direct Material Components Standard Direct Labor Components Manufacturing Overhead Variable Overhead Fixed Overhead © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Variance Variance is the difference between an actual cost and a standard cost. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Total Variance Total actual cost incurred minus total standard cost applied to output produced Actual price of actual production input Standard cost of actual production output Total Variance* *Favorable or unfavorable © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Total Variance AP x AQ SP x SQ 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 © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Price Variance AP x AQ SP x AQ SP x SQ Price/Rate Variance Total Variance What was paid (AP – SP) x AQ* What should have been paid *Favorable or unfavorable © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Usage Variance AP x AQ What was used SP x AQ SP x SQ Usage Variance Total Variance (AQ – SQ) x *Favorable or unfavorable SP* What should have been used for the level of output © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Material Price Variance (MPV) AP x AQ SP x AQ SP x SQ MPV Total Variance What was paid (AP – SP) x AQ* What should have been paid *Favorable or unfavorable © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. MPV Calculations Calculate MPV at Point of purchase or When materials used © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Material Quantity Variance (MQV) AP x AQ SP x AQ SP x SQ MQV What was used Total Variance (AQ – SQ) x *Favorable or unfavorable SP* What should have been used for level of output © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Labor Rate Variance (LRV) AP x AQ SP x AQ SP x SQ LRV Total Variance What was paid (AP – SP) x AQ* What should have been paid *Favorable or unfavorable © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Labor Efficiency Variance (LEV) AP x AQ SP x AQ SP x SQ LEV What was used Total Variance (AQ – SQ) x *Favorable or unfavorable SP* What should have been used for level of output © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Overhead Variances Variable Overhead Fixed Overhead Actual variable overhead is total of various ledger accounts Actual fixed overhead is total of various ledger accounts SP = Predetermined variable overhead rate SP = Predetermined fixed overhead rate © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Variable Overhead Variances Actual VOH Actual For actual hours used Budgeted VOH Applied VOH SP x AQ SP x SQ VOH Spending Variance VOH Efficiency Variance Total VOH Variance What should have been used for level of output © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. VOH Spending Variance Caused by price differences Managers have little control over prices Caused by shrinkage or waste Managers should be held accountable © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Fixed Overhead Variances Actual FOH Budgeted FOH Applied FOH SP x SQ Constant Amount FOH Spending Variance FOH Volume Variance Total FOH Variance What should have been used for level of output © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. FOH Spending and Volume Variance FOH Spending Variance Calculate variance for each component Caused by price differences May reflect mismanagement of resources FOH Volume Variance 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 © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Alternative Overhead Variance Approaches One variance Two variance Three variance Four variance © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. One Variance Approach Standard Cost of OH SP x SQ Actual OH Total OH Variance Applied Overhead © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Two Variance Approach Actual Budgeted OH Standard OH based on SQ Cost of OH SP x SQ Budget Variance Volume Variance Total OH Variance Applied Overhead © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Three Variance Approach Actual OH Budgeted OH based on based on Actual Inputs Actual Output Standard OH SP x SQ OH Spending Variance OH Efficiency Variance Total OH Variance Volume Variance Applied Overhead © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Standard Cost Journal Entries Variances recorded in accounting system Favorable variances Unfavorable variances Credits Represent savings in production costs Debits Represent excess production costs Inventories are recorded at standard cost during the period © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Purchase of Materials (Point of Purchase Method) At Standard Cost Materials SP x AQ purchased Materials Price Variance U Accts Pay F AP x AQ purchased Debit—Unfavorable Credit—Favorable © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Use of Materials At Standard Cost WIP SP x SQ allowed Materials Quantity Variance U Materials F SP x AQ used Debit—Unfavorable Credit—Favorable © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Record Labor LRV At Standard Cost U F LEV U F WIP Wages Pay AP x AQ SP x SQ allowed Debit—Unfavorable Credit—Favorable © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Apply Overhead WIP SP x SQ Allowed VOH SP x SQ Allowed FOH SP x SQ Allowed © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Year-End Treatment for VOH VOH Efficiency Variance VOH Spending Variance VOH Actual Applied --------------- Debit—Unfavorable Credit—Favorable Enter a debit or credit to bring balance to zero © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Year-End Treatment for FOH FOH Spending Variance Volume Variance FOH Actual Applied ------------- Debit—Unfavorable Credit—Favorable Enter a debit or credit to bring balance to zero © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Year-End Treatment of Variances Immaterial—Adjust Cost of Goods Sold Material—Prorate variances to: Material Price Variances Raw Materials WIP Finished Goods Cost of Goods Sold All other variances WIP Finished Goods Cost of Goods Sold © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Why Use Standard Cost Systems Motivation Planning Controlling—variance analysis Decision making Performance evaluation © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Setting Standards and Trends Setting Standards Appropriateness Attainability Expected standards Practical standards Ideal standards Trends in Standards Ideal Standards and Theoretical Capacity Adjusting standards Price variance on purchase versus usage Decline in direct labor content © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Conversion Costs Combine direct labor and manufacturing overhead Variances Spending variance for overhead Efficiency variances for machinery and production costs Volume variances for production © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Material Price, Mix, and Yield Variances AM x AQ x AP Material Price Variance AM—Actual Mix SM—Standard Mix AM x AQ x SP SM x AQ x SP Material Mix Variance SM x SQ x SP Material Yield Variance What should have been used for level of output? © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Labor Rate, Mix, and Yield Variances AM x AH x AR Labor Rate Variance M—Mix H—Hours R—Rate AM x AH x SR SM x SH x SR SM x AH x SR Labor Mix Variance Labor Yield Variance What should have been used for level of output? © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Questions How are standards set for material, labor, and overhead? How is variance analysis used for control and performance evaluation? Why are labor and overhead elements sometimes combined into a single conversion element? © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 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 © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.