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Chapter Eleven

Standard Costs and Variance Analysis

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Standards and Standard Costs

A standard cost is the per-unit cost a company should incur to make a unit of product. A price and quantity is set for each input

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Approaches Used To Set Standards

Engineering methods

Managerial estimates

Benchmarking and Best Practices

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What Standard?

An ideal standard can be attained only under perfect conditions.

Setting a currently attainable standard recognizes expectations about efficiency under normal working conditions.

An historical standard is based on experience.

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Standards - Pros and Cons

Pro: Work well in mature industries where focus

is on cost control and price competition Con: Problematic in industries with frequent

technical changes in products Don’t encourage improvement

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BenchmarkingBenchmarking is a relatively recent development that companies use to determine whether their operations and costs compare favorably to those of world-class companies.

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Standard Costs Cost Factor Std. Quality Std. Price Std. Cost

Materials 20 feet $0.80 $16.00

Direct labor 1/2 hour 10.00 5.00

Overhead 2.50

$23.50

Actual results:

Crates produced 1,000

Materials purchased (23,000 feet) $18,860

Direct labor (480 hours at $10.10) $4,848

Overhead $2,400

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Variance Analysis For each input a price and a quantity standard is

determined At the end of the period the actual input cost is

compared to the flexible budget and the difference is analyzed into price and quantity effects

Price variance is the difference in price paid from standard price times the actual quantity of input

Quantity variance is the difference in quantity used from standard quantity allowed times the standard price of the input per unit

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Generic Variance AnalysisQuantityVarianceName

PriceVarianceName

QuantityVarianceFormula

PriceVarianceFormula

Directmaterial

Usage Price SP (SQ-AQ) AQ(SP-AP)

DirectLabor

Efficiency Rate SR(SH-AH) AH(SR-AR)

A - Actual H - Hours P- Price R - Rate per hour S - Standard

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Actual Input Quantity

at Actual Rates(Total Actual

Costs)

Flexible Budget Allowance Based on Actual Quantity of Input at Standard

Rate

Flexible Budget Allowance Based on Actual Quantity of Output at Standard

Rate(Total Standard Costs)

18,860 23,000*0.80 =18400 1,000 x 20*0.80 = 16,000

$460 U

price variance usage variance

$2860U

Total Variance

$2,400 U

Material Variances

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Actual Input Quantity

at Actual Rates(Total Actual

Costs)

Flexible Budget Allowance Based on Actual Quantity of Input at Standard

Rate

Flexible Budget Allowance Based on Actual Quantity of Output at Standard

Rate(Total Standard Costs)

4,848 480 x $10.00 1,000*10*0.5

$48 U

rate variance efficiency variance

$152 F

Total Variance

$200 F

Labor Variances

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Overhead Variances Overhead variances consist of the controllable

variance and the volume variance Controllable variance is the difference between

the actual overhead and the flexible budget for the actual activity level (flexible budget variance)

Volume variance is the difference between the applied overhead and the flexible budget. It arises because a different number of units was produced than was used in determining the unit cost. Relates only to fixed overhead.

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Overhead Cost DevelopmentAssume that the overhead budget and volume used

to develop the $2.50 per unit were as follows:

Budget formula OH = $1,800 + $0.50 per unit

Expected volume is 900 units

Overhead is (1800 + (0.50*900))/900 = 2.00 + 0.50 = $2.50 per unit of which $2.00 is fixed and $0.50 is variable

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Overhead VarianceAnalysis Format

Actual Overhead$2,400

Flexible Budgetfor actual output

1,800 + 1,000 * 0.502,300

Applied Overhead1,000 * 2.50

2,500

ControllableVariance

100 U

Volume Variance

200 F

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Analysis of Overhead Variances Controllable variance is unfavorable because

the budget for 1,000 units is $1,800 + 1,000*0.50 or $2,300 and the actual spending was $2,400.

The volume variance is favorable because more untis were produced that was originally planned (1,000 versus 900).

The amount is the fixed cost per unit (1,800/900) times the excess production (100 units)

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Management by Exception

Management by exception says that we assume things are fine unless given information to the contrary.

Investigate variances that fall outside of normal limits

Also look for trends in variances that are in normal limits.

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Issues That Complicate the Interpretation of Variances Variances signal nonstandard

performance only if they are based on up-to-date standards that reflect current production methods and current prices of input factors.

Many variances are interdependent.

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Nonfinancial Measurers

Supplies of inventories

Cycle time

Setup time

Percentage of deliveries to customers made on-time

Quality measures

Throughput measures