Standard Costs and Variances

1. Standard Costs and Variances Chapter 10

2. Standard Costs Standards are benchmarks or “norms” formeasuring performance. In managerial accounting, two types of standards are commonly used. Quantity standardsspecify how much of aninput should be used tomake a product orprovide a service. Price standardsspecify how muchshould be paid foreach unit of theinput. Examples: Firestone, Sears, McDonald’s, hospitals, construction, and manufacturing companies.

3. Standard Quantityper Unit Final, deliveredcost of materials,net of discounts. Summarized in a Bill of Materials. Setting Direct Materials Standards Standard Priceper Unit

4. Standard Rateper Hour Standard Hoursper Unit Often a singlerate is used that reflectsthe mix of wages earned. Use time and motion studies foreach labor operation. Setting Direct Labor Standards

5. PriceStandard QuantityStandard The rate is the variable portion of the predetermined overhead rate. The quantity is the activity in the allocation base for predetermined overhead. Setting Variable Manufacturing Overhead Standards

6. Quantity Variance Price Variance Difference betweenactual quantity and standard quantity A General Model for Variance Analysis Variance Analysis Difference between actual price andstandard price

7. The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used. • The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production. Price and Quantity Standards Price and quantity standards are determined separately for two reasons:

8. A General Model for Variance Analysis Variance Analysis Price Variance Quantity Variance Materials price varianceLabor rate varianceVOH rate variance Materials quantity variance Labor efficiency variance VOH efficiency variance

9. A General Model for Variance Analysis (3) Standard QuantityAllowed for Actual Output,at Standard Price(SQ × SP) (1)Actual Quantityof Input,at Actual Price (AQ × AP) (2)Actual Quantityof Input,at Standard Price(AQ × SP) Price Variance(2) – (1) Quantity Variance(3) – (2) Spending Variance(3) – (1)

10. A General Model for Variance Analysis Actual quantity is the amount of direct materials, direct labor, and variable manufacturing overhead actually used. (3) Standard QuantityAllowed for Actual Output,at Standard Price(SQ × SP) (1)Actual Quantityof Input,at Actual Price (AQ × AP) (2)Actual Quantityof Input,at Standard Price(AQ × SP) Price Variance(2) – (1) Quantity Variance(3) – (2) Spending Variance(3) – (1)

11. A General Model for Variance Analysis Standard quantity is the standard quantity allowed for the actual output of the period. (3) Standard QuantityAllowed for Actual Output,at Standard Price(SQ × SP) (1)Actual Quantityof Input,at Actual Price (AQ × AP) (2)Actual Quantityof Input,at Standard Price(AQ × SP) Price Variance(2) – (1) Quantity Variance(3) – (2) Spending Variance(3) – (1)

12. A General Model for Variance Analysis Actual price is the amount actuallypaid for the input used. (3) Standard QuantityAllowed for Actual Output,at Standard Price(SQ × SP) (1)Actual Quantityof Input,at Actual Price (AQ × AP) (2)Actual Quantityof Input,at Standard Price(AQ × SP) Price Variance(2) – (1) Quantity Variance(3) – (2) Spending Variance(3) – (1)

13. A General Model for Variance Analysis Standard priceis the amount that shouldhave been paid for the input used. (3) Standard QuantityAllowed for Actual Output,at Standard Price(SQ × SP) (1)Actual Quantityof Input,at Actual Price (AQ × AP) (2)Actual Quantityof Input,at Standard Price(AQ × SP) Price Variance(2) – (1) Quantity Variance(3) – (2) Spending Variance(3) – (1)

14. Purchasing Manager Production Manager Responsibility for Materials Variances Materials Price Variance Materials Quantity Variance The standard price is used to compute the quantity varianceso that the production manager is not held responsible forthe purchasing manager’s performance.

15. Mix of skill levelsassigned to work tasks. Level of employee motivation. Quality of production supervision. Production Manager Quality of training provided to employees. Responsibility for Labor Variances Production managers areusually held accountablefor labor variancesbecause they caninfluence the:

16. Advantages Advantages of Standard Costs Standards canprovide benchmarksthat promote economy and efficiency. Standard costs area key element ofthe management byexception approach. Standards can greatly simplifybookkeeping. Standards cansupport responsibilityaccounting systems.

17. PotentialProblems Potential Problems with Standard Costs Standard cost variancereports are usuallyprepared on a monthlybasis and may contain information that isoutdated. If variances are misusedas a club to negativelyreinforce employees,morale may suffer andemployees may make dysfunctional decisions. Labor variances assume that the production process is labor-pacedand that labor is a variable cost. These assumptions are often invalid in today’s automated manufacturing environment where employeesare essentially a fixed cost.

18. PotentialProblems Potential Problems with Standard Costs Just meeting standardsmay not be sufficient;continuous improvementmay be necessary tosurvive in a competitiveenvironment. In some cases, a “favorable” variancecan be as bad orworse than anunfavorable variance. Excessive emphasis on meeting the standards may overshadow otherimportant objectives such as maintaining and improving quality, on-time delivery, and customer satisfaction.

19. End of Chapter 10