Using Variances under Standard

Cost System

ACG 2071Module 10

Chapter 22Fall 2007

Standards Are performance goals. Service, merchandising, and manufacturing

businesses may all use standards to evaluate and control operations.

Manufacturers normally use standard costs for each of the three manufacturing costs Direct materials Direct labor Factory overhead

Standard Cost Systems Accounting systems that use standards for these

costs are called standard cost systems. Management determines how much a product should

cost – Standard Cost How much it does cost – Actual Cost The causes of any differences – Variances When actual costs are compared with standard costs,

only the exceptions or variances are reported for cost control. Called Principle of Exceptions.

Standard costs assists management in controlling costs and in motivating employees to focus on costs.

Types of Standards Theoretical or ideal standards – achieved

only under perfect conditions Currently attainable or normal standards –

attained with reasonable effort

Budgetary Performance Evaluation When using standard cost system, direct

materials, direct labor, and factory overhead are separated into two components A price standard A quantity standard

Example Assume that Halycon Balloons produced and sold 5,000 hot air balloons.

It incurred direct material costs of $40,150, direct labor costs of $38,500, and factory overhead costs of $22,400. The standard costs for the company are listed below:

Manufacturing Costs

Standard Price Standard Quantity per

unit

Standard Cost per

Unit

Direct materials $5.00 per yard 1.5 yards $7.50

Direct labor $9.00 per hour 0.80 hour per unit $7.20

Factory overhead $6.00 0.80 hour per unit $4.80

Total standard cost per unit

$19.50

Budget Performance ReportManufacturing Costs

Actual Costs Standard Costs at Actual Volume

Cost Variance (Favorable) Unfavorable

Direct materials $40,150 $37,500 $2,650

Direct labor $38,500 $36,000 $2,500

Factory overhead

$22,400 $24,000 ($1,600)

Total standard cost per unit

$101, 050 $97,500 $3,550

Budget Performance Report Favorable cost variance occurs when the

actual cost is less than the standard cost Unfavorable variance occurs when the

actual cost is greater than the standard cost

Variance Analysis Types of variances

Direct Materials Direct Labor Factory Overhead

Direct Materials Variance

Price variance = (Actual price – Standard Price) X Actual Quantity

Quantity variance = (Actual Quantity – Standard Quantity) X Actual Price

Total Direct Materials Variance = Quantity Variance + Price Variance

Example Material used in the production of Z

Cleaner has a standard cost of $3 per lb. and standard use of 10,000 lbs. Actual records show 15,000 lbs were used with an actual cost of $2.50 per lb. Compute the direct material variances.

ExamplePrice Variance = (Actual Price – Standard Price) X Actual Quantity = ($2.50 – $3) X 15,000 lbs = -$0.50 X 15,000 lbs = -$7,500 favorable

Quantity Variance = (Actual Quantity – Standard Quantity) X Standard Price

= (15,000 lbs – 10,000 lbs) X $3.00 = 5,000 lbs x $3.00 = $15,000 UnfavorableTotal direct materials variance = Quantity variance + Price variance = $15, 000 + (-$7,500) = $7,500 Unfavorable

Direct Labor Variance

Rate variance = (Actual Rate – Standard Rate) X Actual Hours

Time variance = ( Actual Hours – Standard Hours) X Actual Rate

Total Direct Labor Variance = Time Variance + Rate Variance

Example Example 4: Factory records show that

each product produced requires 3 direct labor hours. Production during the period consisted of 10,000 units with 29,500 hours of labor used. Labor has a standard cost of $10 per hour and actual cost was $11 per hour. Compute the direct labor variances.

Example

Rate Variance = (Actual Rate – Standard Rate) X Actual hours

= ($11 - $10) X 29,500 hours

= $29,500 Unfavorable

Example

Time Variance = (Actual hrs – Standard hrs) X Standard rate

= [29,500 hrs – ( 3 x 10,000)] x $10

= -500 hours x $10

= -$5,000 Favorable

Example

Total Direct labor variance = Rate variance + Time variance = $29,500 + (-$5,000) = $24,500 Unfavorable

Factory Overhead Variance Determine the impact of changing production on

fixed and variable factory overhead cost. Variances from standard for factory overhead

cost result from: Actual variable factory overhead cost greater or less

than budgeted variable factory overhead for actual production

Controllable variance for variable factory overhead Actual production at a level above or below 100% of

normal capacity. Volume variance for fixed factory overhead

Example  Percent of normal capacity 80% 90% 100% 110%

Units produced 5,000 5,625 6,250 6,875

Direct labor hours ( .8 per unit) 4,000 4,500 5,000 5,500

Budgeted factory overhead

Variable costs:

Indirect factory wages $8,000 $9,000 $10,000 $11,000

Power and light 4,000 4,500 5,000 5,500

Indirect materials 2,400 2,700 3,000 3,300

Total variable cost $14,400 $16,200 $18,000 $19,800

Fixed costs:

Supervisory salaries $5,500 $5,500 $5,500 $5,500

Depreciation 4,500 4,500 4,500 4,500

Insurance 2,000 2,000 2,000 2,000

Total fixed cost $12,000 $12,000 $12,000 $12,000

Total factory overhead $26,400 $28,200 $30,000 $31,800

Controllable VarianceControllable Variance

Deals with variable cost

Actual variable factory overhead-Budgeted variable factory overhead* Controllable Variance

*at actual production level

Example Halycon produced 5,000 balloons and each

unit required 0.80 standard labor hour for production. Actual variable factory overhead was $10,400 and fixed factory overhead was $12,000 Using the information on Halycon Balloons, compute the controllable variance.

Standard direct labor hours5,000 units produced x 0.80 per hour = 4,000 direct labor

Based on units produced

Variable costs per unit Variable costs per unit

= Total variable factory overhead Total hours

= $18,000 = $ 3.60 per hour5,000

Budgeted Variable Factory Overhead Standard direct labor hours for units produced

x Standard variable factory overhead per DLHBudgeted variable factory overhead

= 4,000 hours x $3.60 = $14,400

Controllable VarianceActual variable factory overhead $16,000Budgeted variable factory overhead 14,400Controllable variance $1,600 UNFAVORABLE

Volume Variance – Fixed costs

100% capacity direct labor hours-Standard direct labor hours at actualCapacity not usedX standard fixed overhead rate

Volume variance

Example : Using the information on Halycon Balloons,

assume actual production at 80% capacity. Compute the volume variance.

From the factory overhead cost budget, we compute:

Fixed costs per unit = Total fixed factory overhead

Total hours

= $12,000 = $ 2.40 per hour 5,000 based on 100% capacity

Volume Variance

100% capacity direct labor hours 5,000 hours-Standard direct labor hours at actual 4,000 hoursCapacity not used 1,000 hoursX standard fixed overhead rate x $2.40Volume Variance $2,400 unfavorable