COST ACCOUNTING 2
Source: http://www.accountingformanagement.com
Introduction to Managerial Accounting (Cost or Management Accounting)
What is Managerial Accounting (Management Accounting / Cost Accounting)?
Managerial accounting is concerned with providing information to managers-that is,
people inside an organization who direct and control its operation. In contrast,
financial accounting is concerned with providing information to stockholders,
creditors, and others who are outside an organization.
Managerial accounting provides the essential data with which the organizations are
actually run. Managerial accounting is also termed as management accounting or cost
accounting. Financial accounting provides the scorecard by which a company's
overall past performance is judged by outsiders. Managerial accountants prepare a
variety of reports. Some reports focus on how well managers or business units have
performed-comparing actual results to plans and to benchmarks. Some reports provide
timely, frequent updates on key indicators such as orders received, order backlog,
capacity utilization, and sales. Other analytical reports are prepared as needed to
investigate specific problems such as a decline in the profitability of a product line.
And yet other reports analyze a developing business situation or opportunity. In
contrast, financial accounting is oriented toward producing a limited set of specific
prescribed annual and quarterly financial statements in accordance with Generally
Accepted Accounting Principles (GAAP). (Ray H. Garrison, Eric W. Noreen 1999).
Standard Costing and Variance Analysis:
Learning Objectives:
Explain how direct materials standard and direct labor standards are set.
Compute the direct materials price and quantity variances and explain their
significance.
Compute the direct labor rate and efficiency variance and explain their significance.
Compute the manufacturing overhead spending and efficiency variance.
Standard Costs and Management By Exception:
A standard cost is the predetermined cost of manufacturing a single unit or a number
of product units during a specific period in the immediate future. It is the planned cost
of a product under current and/or anticipated operating conditions. Click here to read
full article.
Setting Standard Costs - Ideal Versus Practical Standards:
Setting price and quantity standards requires the combined expertise of all persons
who have responsibility over input prices and over effective use of inputs. In a
manufacturing firm, this might include accountants, purchasing managers, engineers,
production supervisors, line mangers, and production workers. Past records of
purchase prices and input usage can help in setting standards. However, the standards
should be designed to encourage efficient future operations, not a repetition of past
inefficient operations. Click here to read full article.
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Direct Materials Standards and Variance Analysis:
Direct Materials Price and Quantity Standards:
Standard price per unit of direct materials is the price that should be paid for a single
unit of materials, including allowances for quality, quantity purchased, shipping,
receiving, and other such costs, net of any discounts allowed. Click her to read full
article.
Direct Materials Price Variance:
Direct materials price variance is the difference between the actual purchase price and
standard purchase price of materials. Direct materials price variance is calculated
either at the time of purchase of direct materials or at the time when the direct
materials are used. Click here to read full article
Direct Materials Quantity Variance:
Direct materials quantity variance or Direct materials usage variance measures the
difference between the quantity of materials used in production and the quantity that
should have been used according to the standard that has been set. Although the
variance is concerned with the physical usage of materials, it is generally stated in
dollar terms to help gauge its importance. Click here to read full article.
Direct Labor Standards and Variance Analysis:
Direct Labor Rate and Efficiency Standards:
Direct labor price and quantity standards are usually expressed in terms of a labor rate
and labor hours. The standard rate per hour for direct labor includes not only wages
earned but also fringe benefit and other labor costs. Click here to read full article
Direct Labor Rate | Price Variance:
Direct Labor price variance is also termed as direct labor rate variance. This variance
measures any deviation from standard in the average hourly rate paid to direct labor
workers. Click here to read full article.
Direct Labor Efficiency | Usage | Quantity Variance:
The quantity variance for direct labor is generally called direct labor efficiency
variance or direct labor usage variance. Click here to read full article.
Manufacturing Overhead Standards and Variance Analysis:
Manufacturing Overhead Standards:
Procedures for the establishing and using standard factory overhead rates are similar
to the methods of dealing with the estimated direct and indirect factory overhead and
its application to jobs and products. Click here to read full article.
Factory Overhead Variances:
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Jobs or processes are charged with cost on the basis of standard hours allowed
multiplied by the standard factory over head rate. The standard overhead rate or
predetermined overhead rate is discussed in detail at our job order costing system
page. The standard hours allowed figure is determined by multiplying the labor hours
required to produce one unit (the standard labor hours per unit) times the actual
number of units produced during the period. The units produced are the equivalent
units of production for the departmental factory overhead cost being analyzed. At the
end of the month, overhead actually incurred is compared with the expenses charged
into process using the standard factory overhead rate. The difference between these
figures is called the overall or net factory overhead variance.
overall or net factory overhead variance needs further analysis to reveal detailed
causes for the variance and to guide management toward remedial action. This
analysis may be made by using (1) the two variance method, (2) the three variance
method, or (3) the four variance method.
The two variance method: When an overall or net factory overhead variance is further
analyzed by using two variance approach, the following two variances are calculated:
Controllable variance
Volume variance
The three variance method: When an overall or net factory overhead variance is
further analyzed by using three variance approach, the following three variances are
calculated:
Spending variance
Idle capacity variance
Efficiency variance
The four variance method: When an overall or net factory overhead variance is further
analyzed by using four variance approach, the following four variances are calculated:
Spending variance
Variable efficiency variance
Fixed efficiency variance
Idle capacity variance
Mix and Yield Variance - Definition and Explanation:
Basically, the establishment of standard product cost requires the determination of
price and quantity standards. In many industries, particularly of the process type,
materials mix and materials yield play significant parts in the final product cost, in
cost reduction, and in profit improvement. Click here to read full article
Calculation of Mix and Yield Variances:
Materials Mix and Yield Variance
Labor Yield Variance
Factory Overhead Yield variance
Variance Analysis and Management By Exception:
Variance analysis and performance reports are important elements of management by
exception. Simply put, management by exception means that the manager's attention
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should be directed toward those parts of the organization where plans are not working
out for reason or another.
Managerial importance and usefulness of variance analysis:
Costs of production are effected by internal factors over which management has a
large degree of control. An important job of executive management is to help the
members of various management levels understand that all of them are part of the
management team. Click here to read full article.
Advantages and Disadvantages of Standard Costing System:
The use of standard costs is a key element in a management by exception approach. If
costs remain within the standards, Managers can focus on other issues. Click here to
read full article
Standard Costing and Variance Analysis Formulas:
Example:
Calculation of standard price per unit of direct materials or raw materials:
Purchase price, top-grade pewter ingots, in $ 3.60
40-pounds ingots
+0.44
Freight, by truck, from suppliers warehouse +0.05
Receiving and handling
Less purchase discount
-0.09
-------Standard price per pound
$4.00
====
Notice that the standard price reflects a particular grade of materials (top grade),
purchased in particular lot size (40 pound ingots), and delivered by a particular type of
carrier (truck). Allowances have also been made for handling and discounts. If every
thing proceeds according to these expectations, the net cost of a pound of pewter
(direct material in the example above) should therefore be $4.00.
Example:
Calculation of standard quantity per unit of direct materials or raw materials:
Materials requirement (in pounds) per unit
as specified in the bill of materials*
Allowance for wastage and spoilage
Allowance for rejects
Standard of materials requirements (in
pounds)
2.7
0.2
0.1
-----3.0
====
*A bill of materials is a list that shows the quantity of each type of material in a unit
of finished product. It is a handy source of determining the basic material input per
unit, but it should be adjusted for waste and other factors as shown above, when
determining the standard quantity per unit of product. "waste and spoilage" in the
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table above refers to materials that are wasted as a normal part of the production
process or that spoil before they are used. "Rejects" refers to the direct material
contained in units that are defective and must be scrapped.
Although it is common to recognize allowances for waste, spoilage, and rejects when
setting standard costs, this practice is now coming into question. Those involved in
total quality management (TQM) and similar other business improvement programs
argue that no amount of waste or defects should be tolerated. If allowances for waste,
spoilage, and rejects are built into the standard cost, the levels of those allowances
should be periodically reviewed and reduced over time to reflect improvement process,
better training, and better equipment.
Once the direct materials price and quantity standards have been set, the standard cost
of a material per unit of finished product can be computed as follows.
3 pounds per unit × $ 4.00 per pond = $ 12 per unit
This $12 cost figure will appear as one item on the product's standard cost card as
shown by the following example.
Example of standard cost card:
Inputs
Direct materials
Direct labor
Variable manufacturing overhead
(1)
(2)
Standard
Standard
Quantity or Price or
Hours
Rate
3.0 pounds
$ 4.00
2.5 hours
$ 14.00
2.5 hours
$ 3.00
Total standard cost per unit
(3)
Standard
Cost
(1) × (2)
$ 12.00
$ 35.00
$ 7.50
$54.50
Definition and Explanation of Direct Materials Price Variance:
Direct materials price variance is the difference between the actual purchase price and
standard purchase price of materials. Direct materials price variance is calculated
either at the time of purchase of direct materials or at the time when the direct
materials are used. When this variance is computed at the time of purchase of
materials it is called direct materials purchase price variance. When this variance is
computed at the time of usage this is typically called direct materials price usage
variance.
Direct materials price variance formula:
Following formula is used to calculate materials price variance:
[Materials Price Variance = (Actual quantity purchased × Actual price) − (Actual
quantity purchased × Standard price)]
This formula is usually preferred and used by managers because it permits calculation
of materials purchase price variance very quickly.
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Example:
Colonial Pewter Company provides the following information:
Standard price of material is $4.00 per pound and 6,500 pounds of materials have bee
purchased at a cost of $3.80 per pound. This cost figure includes freight and handling
and is net of quantity discount. All the materials purchased has been used and an
output of 2000 units is produced during the period.
Required: Calculate materials price variance.
Calculation of direct materials price variance:
= (6,500 pounds × $3.80) − (6,500 pounds × $4.00)
= $24,700 − $26,000
= $1,300 Favorable
A favorable material price variance of $1,300 exists because the actual price of
materials purchased is less than the standard price of materials purchased. A material
price variance is called unfavorable materials price variance if the actual price of
materials purchased is more than the standard price of materials purchased.
Variance analysis reports are often issued in a tabular format. An example of such a
variance report follows along with an explanation for the materials price variance that
has been calculated above for Colonial Pewter Company.
Colonial Pewter Company
Performance Report - Purchasing Department
Item
Quantity
Actual Standard Difference Total Price
Purchased Purchased Price
Price
in Price
Variance
1
2
3
4
5
(2) – (3)
(1) × (4)
Pewter
6,500
$3.80
$4.00
$0.20
$1,300Favorabl
pounds
Explanation
Bargained
for an
especially
good price
Exercises:
Exercise 1: Materials Variance Analysis
The Schlosser Lawn Furniture Company uses 12 meters of aluminum pipe at $0.80
per meter as standard for the production of its Type A lawn chair. During one month's
operations, 100,000 meters of the pipe were purchased at $0.78 a meter, and 7,200
chairs were produced using 87,300 meters of pipe. The materials price variance is
recognized when materials are purchased. Calculate materials price variance.
Solution:
Meters of pipe
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Unit Cost
Amount
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Actual quantity purchased
actual quantity purchased
Materials purchase price
variance
100,000
100,000
100,000
$0.78 actual
$0.80 standard
$(0.02)
$78,000
$80,000
$(2,000)
fav.
Exercise 2: Materials Variance Analysis
The standard price for material 3-291 is $3.65 per liter. During November, 2,000 liters
were purchased at $3.60 per liter. The quantity of material 3-291 issued during the
month was 1775 liters and the quantity allowed for November production was 1,825
liters. Calculate materials price variance, assuming that:
It is recorded at the time of purchase (Materials purchase price variance).
It is recorded at the time of issue (Materials price usage variance).
Solution:
Actual quantity purchased
Actual quantity purchased
Materials purchase price
variance
Actual quantity used
Actual quantity used
Materials price usage
variance
Liters
2,000
2,000
2,000
Unit cost
3.60 actual
3.65 standard
$ (0.05)
Amount
$7,200
7,300
$(100) fav.
1775
1775
1775
3.60 actual
3.65 standard
$(0.05)
$6390.00
$6478.75
(88.75)
Definition and Explanation of Direct Material Quantity Variance:
Direct materials quantity variance is also known as Direct materials efficiency
variance and Direct materials usage variance. It measures the difference between the
quantity of materials used in production and the quantity that should have been used
according to the standard that has been set. Although the variance is concerned with
the physical usage of materials, it is generally stated in dollar terms to help gauge its
importance.
Materials quantity | Usage variance Formula:
Following formula is used to calculate materials quantity variance or direct materials
usage variance:
[Materials quantity variance = (Actual quantity used × Standard price) − (Standard
quantity allowed × Standard Price)]
Example:
Colonial Pewter Company provides the following data:
3.0 pounds of materials are required to produce a unit of product according to
standards set by the management. The standard price of direct materials is $4.00 per
pound. During the period 2000 unit were completed with an actual consumption of
6,500 pounds of direct materials.
Calculate direct materials quantity variance or direct materials usage variance.
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According to above information, the calculation of materials quantity variance is as
follows:
Calculation of Materials Quantity Variance = (Actual quantity used × Standard price)
− (Standard quantity allowed × Standard price)
=(6,500 pounds × $4.00) − (6,000* pounds × $4.00)
= $26,000 − $24,000
= 2000 Unfavorable
*Standard quantity allowed (3.00 per unit × 2,000 units)
Colonial Pewter Company
Performance Report - Production Department
(1)
(2)
(3)
(4)
(5)
Type of
Materials
Standard
Price
Actual
Quantity
Standard
Quantity
Allowed
Difference
in Quantity
(2) – (3)
Total
Quantity
Variance
(1) × (4)
Explanation
Pewter
$4.00
6,500
Pounds
6,000
Pounds
500
Pounds
$2,000
Unfavorable
Low quality
materials
unsuitable
for
production
Above calculation shows an unfavorable direct materials quantity variance. When
materials are used more than what is allowed by standard an unfavorable quantity
variance occurs. If materials used is less than the quantity allowed a favorable direct
materials quantity variance occurs.
Exercises:
Exercise 1: Materials Variance Analysis
The Schlosser Lawn Furniture Company uses 12 meters of aluminum pipe at $0.80
per meter as standard for the production of its Type A lawn chair. During one month's
operations, 100,000 meters of the pipe were purchased at $0.78 a meter, and 7,200
chairs were produced using 87,300 meters of pipe. The materials price variance is
recognized when materials are purchased. Calculate materials materials quantity
variance | direct materials efficiency variance.
Solution:
Actual quantity used
Standard quantity allowed
87,300
86,400
--------900
$0.80 standard
$0.80 standard
---------------$0.80
$69,840
$69,120
--------$720 unfav.
=======
=======
=======
Materials quantity variance
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Direct Labor Rate Standards:
The standard rate per hour for direct labor includes not only wages earned but also
fringe benefit and other labor costs.
Example of Standard rate per direct labor hour:
Basic wages rate per hour
Employment taxes at 10% of the basic rate
Fringe benefits at 30% of the basic rate
Standard rate per direct labor hour
$10
$ 1
$ 3
----$14
====
Many companies prepare a single standard rate for all employees in a department.
This standard rate reflects the expected "mix" of workers, even though the actual
wage rates may very somewhat from individual to individual due to different skills of
seniority. A single standard rate simplifies the use of standard costs and also permits
the managers to monitor the use of employees within department.
Direct Labor efficiency | Usage | Quantity Standards:
The standard direct labor time required to complete a unit of product (called the
standard hours per unit) is perhaps the most difficult standard to determine. One
approach is to divide each operation performed on the product into elemental body
movements (such as reaching, pushing, and turning over). Standard times for such
movements are available in reference works. These standard times can be applied to
the movements and then added together to determine the total standard time allowed
per operation. Another approach is for an industrial engineer to do a time and motion
study, actually clocking the time required for certain tasks. The standard time should
include allowances for breaks, personal needs of employees, cleanup, and machine
downtime.
Example of standard labor hours per unit:
Basic labor time per unit, in hours
Allowance for breaks and personal need
allowance for cleanup and machine
downtime
Allowance for rejection
Standard labor hours per unit of product
1.9
0.1
0.3
0.2
------2.5
Standard labor hours per unit and standard direct labor rate per hours computed above
shall be used in calculating labor rate variance and labor efficiency variance. Once the
rate and time standards have been set, the standard labor cost per unit of product can
be computed as follows:
2.5 hours per unit × $14 per hour = $35 per unit
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This $35 per unit standards labor cost appears along with direct materials on the
standard cost card of the product as shown by the following example.
Example of Standard Cost Card:
Inputs
(1)
Standard Quantity
or Hours
(2)
Standard Price or
Rate
(3)
Standard Quantity
or Hours
(1) × (2)
3.0 pounds
2.5 hours
2.5 hours
$ 4.00
$ 14.00
$ 3.00
$ 12.00
$ 35.00
$ 7.50
Direct materials
Direct labor
Variable manufacturing
overhead
Total standard cost per
unit
$54.50
Direct Labor Rate | Price Variance:
Learning Objective of the articles:
Define and explain "direct labor rate | price variance" .
How direct labor rate or price variance is calculated?
What are the reasons / causes of favorable and unfavorable labor rate variance?
Definition and Explanation:
Direct Labor price variance is also termed as direct labor rate variance. This variance
measures any deviation from standard in the average hourly rate paid to direct labor
workers. In other words, direct labor rate variance is the difference between the
amount of actual hours worked at actual rate and actual hours worked at standard rate.
Direct Labor Rate Variance Formula:
Following formula is used to calculate direct labor rate variance or direct labor price
variance:
[Labor rate variance = (Actual hours worked × Actual rate) − (Actual hours worked ×
Standard rate)]
Example:
Suppose that 2,000 units have been produced during the period and 5,400 direct labor
hours have been worked at a rate of $13.75 per direct labor hour. Standard rate per
direct labor hour is $14.00.
Calculate labor rate variance.
Calculation of direct labor rate variance.
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Labor rate variance = (Actual hours worked × Actual rate) − (Actual hours worked ×
Standard rate)
= (5,400 × $13.75) − (5,400 × $14.00 )
= 74,250 − 75,600
Labor rate variance = $(1,350) Favorable
Calculation shows a favorable labor rate variance because actual rate paid to workers
is less than standard rate. When the actual rate is more than the standard rate an
unfavorable labor rate variance results.
Rates paid to the workers are usually predictable. Nevertheless, rate variances can
arise through the way labor is used. Skill workers with high hourly rates of pay may
be given duties that require little skill and call for low hourly rates of pay. This will
result in an unfavorable labor rate variance, since the actual hourly rate of pay will
exceed the standard rate specified for the particular task. In contrast, a favorable rate
variance would result when workers who are paid at a rate lower than specified in the
standard are assigned to the task. However, the low pay rate workers may not be as
efficient. Finally, overtime work at premium rates can be reason of an unfavorable
labor price variance if the overtime premium is charged to the labor account.
Exercises:
Exercise 1: Labor Variance Analysis
The processing of a product requires a standard of 0.8 direct labor hours per unit for
Operation 4-802 at a standard wage rate of $6.75 per hour. The 2,000 units actually
required 1,580 direct labor hours at a cost of $6.90 per hour.
Required: Calculate labor rate variance or Labor price variance.
Solution:
Time
Actual hours worked
Actual hours worked
Labor rate variance
Rate
1,580
1.580
-------1,580
$6.90 actual
$6.75 standard
-------$0.15
Amount
$10,902
10,665
-------$237 unfav.
Direct Labor Efficiency Variance
Definition and Explanation:
The quantity variance for direct labor is generally called direct labor efficiency
variance or direct labor usage variance. This variance measures the productivity of
labor time. No variance is more closely watched by management, since it is widely
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believed that increasing the productivity of direct labor time is vital to reducing costs.
The formula for the labor efficiency variance is expressed as follows:
Formula of labor efficiency variance:
[Labor efficiency variance = (Actual hours worked × Standard rate) − (Standard hours
allowed × Standard rate)]
Example:
A company produces 2000 units of finished products using 5,400 hours. Standard
time allowed for a unit of finished product is 2.5 hours. Standard rate that is paid to
workers is $14.00 per direct labor hour.
Calculate direct labor efficiency variance or direct labor quantity variance.
Calculation of direct labor efficiency or quantity or usage variance.
Labor efficiency variance = (Actual hours worked × Standard rate) − (Standard hours
allowed × Standard rate)
= (5,400 × $14.00 ) − (5,000* × $14.00)
= $75,600 − $70,000
= $5,600 Unfavorable
5,000* = 2,000 actual production × 2.50 standard hour allowed per unit
Processing of 2000 units required more time than what was allowed by standards. The
result is an unfavorable labor efficiency variance. A favorable labor efficiency
variance occurs when actual processing time is less than the time allowed by
standards.
Exercises:
Exercise 1: Labor Variance Analysis
The processing of a product requires a standard of 0.8 direct labor hours per unit for
Operation 4-802 at a standard wage rate of $6.75 per hour. The 2,000 units actually
required 1,580 direct labor hours at a cost of $6.90 per hour.
Required: Calculate labor efficiency variance or Labor usage variance.
Solution:
Actual hours worked
Standard hours
allowed
Labor rate variance
Time
Rate
Amoun
1,580
1,600
$6.75 standard
$6.75 standard
$10,665
10,800
-------(20)
-------$6.75
-------$(135) fav.
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