Cost Accounting

Foundations and Evolutions

Kinney, Prather, Raiborn

Chapter 7
Standard Costing and
Variance Analysis
 Learning Objectives (1 of 2)
• Describe how standards are set for material,
labor, and overhead
• List the documents that are associated with
standard cost systems and describe the
information that those documents provide
• Calculate and record material, labor, and
overhead variances
 Learning Objectives (2 of 2)
• Explain why standard cost systems are used
• Contrast the traditional labor and overhead
elements to a single conversion element
• (Appendix) Explain how multiple material
and labor categories affect variances
 Standard Cost Systems
• Manufacturing
Actual
• Service Costs
• Not-for-Profit Incurred

• Record standard and actual costs

in the accounting records
 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
 Manufacturing Objective
Minimize unit cost while achieving
certain quality specifications

Input Output
Resources Quality
 Material Standards
• Materials used
– Types
– Quantity
– Quality
– Cost
• From
– Product specifications, observation, inquiry
– Bill of materials
• Balance cost, quality, and projected sales price
• Insert Exhibit 7-1 BOM
 Material Standards
Standard
Material = Quantity * Unit Purchase Price
Cost
 Labor Standards
• Labor used
– Types
• Production, setup, cleanup, and rework
– Quantity
– Cost
• Include wages, payroll taxes, and fringe benefits
• From
– Time and motion studies, industrial engineering
studies
– Operations flow document
• Exhibit 7-3
 Labor Standards
Standard
Labor = Hours * Wage Rate
Cost
 Overhead Standards
• Variable and fixed manufacturing overhead
• Estimated level of activity
• Estimated costs
• Predetermined factory overhead application
rates
 Standard Cost Card
For one unit of output (a bike)
Standard Direct Material Components
Standard Direct Labor Components
Manufacturing Overhead
Variable Overhead
Fixed Overhead
• Exhibit 7-4
 Variance
Variance is the
difference between
an actual cost and
a standard cost
 Total Variance
Total actual cost incurred minus
total standard cost applied to output produced

Actual price of Standard cost of

actual actual
production input production
output

Total Variance*
*
Favorable or unfavorable
 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
 Price Variance
AP x AQ SP x AQ SP x SQ
Price/Rate
Variance
Total Variance
What
was What should
(AP - SP) x AQ *
have been
paid
paid
*
Favorable or unfavorable
 Usage Variance
AP x AQ SP x AQ SP x SQ
Usage
Variance
Total Variance
What
was What should
used (AQ - SQ) x SP *
have been
used for the
*
Favorable or unfavorable level of output
 Material Price Variance (MPV)
AP x AQ SP x AQ SP x SQ

MPV
Total Variance
What
was What should
(AP - SP) x AQ *
have been
paid
paid
*
Favorable or unfavorable
 Material Price Variance
• Calculate Material Price Variance at
– point of purchase, or
– when materials used
Material Quantity Variance (MQV)
AP x AQ SP x AQ SP x SQ

MQV
Total Variance
What
was What should
used (AQ - SQ) x SP *
have been
used for
*
Favorable or unfavorable level of output
• Exhibit 7-5
 Labor Rate Variance (LRV)
AP x AQ SP x AQ SP x SQ

LRV
Total Variance
What
was What should
(AP - SP) x AQ *
have been
paid
paid
*
Favorable or unfavorable
 Labor Efficiency Variance (LEV)
AP x AQ SP x AQ SP x SQ

LEV
Total Variance
What
was What should
used (AQ - SQ) x SP *
have been
used for
*
Favorable or unfavorable level of output
 Overhead Rates
• Capacity Levels
– Theoretical capacity
– Practical capacity
– Normal capacity
– Expected capacity
• Flexible budgets
– Expected overhead costs at different activity levels
 Overhead Variances
Variable Overhead Fixed Overhead
Actual variable overhead Actual fixed overhead is
is total of various total of various ledger
ledger accounts accounts

SP = Predetermined SP = Predetermined
variable overhead rate fixed overhead rate
 Variable Overhead Variances
Actual Budgeted Applied
VOH VOH VOH
Actual SP x AQ SP x SQ
VOH VOH
Spending Efficiency
For Variance Variance
actual Total VOH Variance
hours
What should have been
used
used for level of output
 VOH Spending Variance
• Caused by price differences
– managers have little control over prices
• Caused by shrinkage or waste
– managers should be held accountable
 Fixed Overhead Variances
Actual Budgeted Applied
FOH FOH FOH
SP x SQ
FOH FOH
Spending Volume
Constant Variance Variance
Amount Total FOH Variance
What should have been
used for level of output
 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
 Alternative Overhead Variance
Approaches
• One variance
• Two variance
• Three variance
• Four variance
One Variance Approach
Actual Standard
OH Cost of
OH
SP x SQ

Total OH Variance
Applied
Overhead
Two Variance Approach
Actual Budgeted OH Standard
OH based on Cost of
Standard OH
Quantity SP x SQ
Budget Volume
Variance Variance
Total OH Variance Applied
Overhead
 Three Variance Approach
Budgeted OH
Actual Standard
based on based on
OH Actual Inputs Standard OH
Quantity
SP x SQ
OH OH
Spending Efficiency Volume
Variance Variance Variance
Total OH Variance
Applied
Overhead
 Four Variance Approach
Budgeted OH
Actual Standard
based on based on
OH Actual Inputs Standard OH
Quantity
SP x SQ
VOH &
FOH VOH
Spending Efficiency Volume
Variances Variance Variance
Total OH Variance
Applied
Overhead
 Standard Cost Journal Entries
• Variances recorded in accounting system
• Favorable variances
– Credits
– Represent savings in production costs
• Unfavorable variances
– Debits
– Represent excess production costs
• Inventories are recorded at standard cost
during the period
 Purchase of Materials
(Point of Purchase Method)
At
Standard
Materials
Cost
Price
Materials Variance Accts Pay
SP x AQ U F AP x AQ
purchased purchased
Debit - Unfavorable
Credit - Favorable
 Use of Materials
At
Standard Materials
Cost Quantity
WIP Variance Materials
SP x SQ U F SP x AQ
allowed used

Debit - Unfavorable
Credit - Favorable
 Record Labor
At Labor
Labor Rate Efficiency
Standard Variance Variance
Cost
U F U F
WIP Wages Pay
SP x SQ AP x AQ
allowed

Debit - Unfavorable
Credit - Favorable
 Apply Overhead
Throughout the Year

WIP VOH FOH

SP x SQ SP x SQ SP x SQ
Allowed Allowed Allowed
 Year-End Treatment for VOH
VOH VOH
Efficiency Spending
Variance Variance VOH
Actual Applied
---------------

Enter a debit
Debit - Unfavorable
or credit to
Credit - Favorable
bring balance
to zero
 Year-End Treatment for FOH
FOH
Spending Volume
Variance Variance FOH
Actual Applied
-------------

Enter a debit
Debit - Unfavorable
or credit to
Credit - Favorable
bring balance
to zero
 Year-End Treatment of Variances
Immaterial - Adjust Cost of Goods Sold
Material - Prorate variances to
Material Price Variance All other variances
• Raw Materials • WIP
• WIP • Finished Goods
• Finished Goods • Cost of Goods Sold
• Cost of Goods Sold
Why Use Standard Cost Systems
• Clerical efficiency
• Motivation
• Planning
• Controlling - variance analysis
• Decision making
• Performance evaluation
 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
 Conversion Costs
• Combine direct labor and manufacturing
overhead
• Variances
– Spending variance for overhead
– Efficiency variances for machinery and
production costs
– Volume variances for production
 Appendix
Mix and Yield Variances
• Mix Variance measures effect of changing
the mix of materials or labor
• Yield Variance measures the difference
between actual and standard inputs for the
output achieved
• Mix Variance plus Yield Variance equals
the Quantity Variance
 Material Mix and Yield Variances
AM x AM x SM x SM x
AQ x AQ x AQ x SQ x
AP SP SP SP

Material Material Material

Price Mix Yield
Variance Variance Variance

AM - Actual Mix What should have been

SM - Standard Mix used for level of output
 Labor Mix and Yield Variances
AM x AM x SM x SM x
AH x AH x AH x SH x
AR SR SR SR

Labor Labor Labor

Rate Mix Yield
Variance Variance Variance

M - Mix
H - Hours What should have been
R - Rate used for level of output
 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?