Cost Variance

Presented By: Afia

Standard Costing, Operational Performance Measures, and the Balanced Scorecard

Ch 10

Cost Management System

Cost management system is planning and controlling system that measure the cost of significant activities, identifies non-value added costs, and identifies activities that will improve organizational performance.

Managerial accountants issued control system to assist managers in controlling an organization’s operations and cost.

Control System

Control system has three basic parts: A predetermined or standard performance

level A measure of actual performance A comparison between standard and actual

performance and then taking corrective actions accordingly.

Standard performance is used as benchmark in budgetary-control system.

To measuring differences in standard and actual is called a cost variance.

Management by Exception

Cost variance used by management in controlling cost.

Management do not consider each variance equally, they select most significant variance to investigate its root causes and measurements are taken strategically to reduce the problem. This process known as Management by Exception.

Setting Standards

Two methods use to set standards:

Analysis of Historic Data It predict future cost based on historic

data. Different methods use to analysis cost

behavior trends. Account classification method Visual fit Method High Low Method Least Square Regression Method

Setting Standards

Task Analysis Determine following according to the task

Cost Direct material use Machinery hours Labor time and performance etc.

Combined Approach Management apply both approaches

collectively under some specific conditions such as advancement of technology in production process.

Setting Standards

Participant in setting standards: Managerial accountants Production Supervisor- set production

cost standards. Sales Manager-set target for sale price

and volume.

Types of Standards: Perfection Standards Practical Standards

Setting Standards

Perfection Standards: Can obtained under perfect operating

conditions. These standards based on some

assumptions: Peak efficiency Lower input price Best quality material No disruption due to machine breakdown

or power failure. Practical Standards:

Attainable standards Assume efficient production process

under normal operating conditions.

Cost Variance Analysis Direct Material standards and variances.

Direct Material Standards Standard Direct Material Quantity Standard Direct Material Price

Example Dcdeserts director of cost management has set

standards for direct material and direct labor for a specific product of multilayer cake.

Direct Material Standards:Standard quantity:

Ingredients in finished product……… 4.75 pounds

Allowances for normal waste………….. .25 pounds

Total standard quantity required per Multilayer fancy cake………….. 5.00

pounds

Direct Material Variances Example

Standard Price:Purchase price per pound of ingredients…….$1.30(net of purchase discount)Transportation cost per pound…………………… .10Total standard price per pound of ingredients…………………………..$1.40

Standard Cost Given Actual Output By taking 2,000 multilayer fancy cakes production.

Direct Material:standard direct material cost per cake(5 pounds*$1.40per pound)…………………….$ 7Actual output………………………………………….*2,000Total standard direct material cost……………$14,000

Direct Material Variances

Example: Following is actual cost incurred during

production:Direct material purchased: actual

cost12500pounds at $1.42per pound……$17,750Direct material used: actual cost 10250 pounds at

$1.42 per pound……….$14,555

Direct Material Variances: Managerial accountant can show these

standard and actual quantity and price differences by computing following variances:

Direct Material Quantity Variance Direct Material Price Variance

Direct Material Variances

Direct Material Price Variance: It is based on the quantity purchased. a difference between actual and standard

price. For effective decision this variance must

calculate as purchases made.

Formula: Direct Material Price Variance= PQ(AP-SP)Where PQ= Quantity Purchased

AP=Actual PriceSP= Standard Price

Direct Material Variances

Variance result can be either favorable or unfavorable.

Example cont.Direct material price variance = PQ(AP-SP)

=12500($1.42-1.40)

=$2.50unfavorable

Direct Material Quantity Variance: Based on how much material consumed in

production. It shows deviation from standard quantity

allowed and actual quantity consumed. This variance must calculate at time of material

use in production.

Direct Material Variances

Formula: Direct Material Quantity Variance= SP(AQ-

SQ)Where AQ= Actual quantity used

SQ=Standard quantity allowed

Example cont..Direct Material Quantity Variance= SP(AQ-SQ)

=$1.40(10250-10,000)

=$350 Unfavorable

Direct Material Variances

Standard quantityAllowed, given actual output

Actual quantity used in the production of actual output

Composition of theseQuantities is the basis of the direct material quantity variance

Cost Variance Analysis

Direct Labor standards and variances Direct Labor Standards A perfection (Ideal) standard is the cost

expected under perfect or Ideal operating conditions.

It includes two activities: Standard Direct Labor Quantity

It is the number of Direct hours normally needed to

manufacture one unit of product. Standard Direct Labor Rate.

It is the total hourly cost of compensation, including wages rate, fringe benefits etc.

Direct Labor Standards Example cont..

Standard quantity:Direct Labor Require per multilayer fancy

cake…. .5hourStandard rate:

Hourly wage rate……………………………………$16Fringe benefits(25% of wages)……………….. 4Total standard rate per hour……………………$20

By taking 2,000 multilayer fancy cakes production Standard Cost Given Actual Output

Direct Labor:Direct Labor cost per cake(.5 hour*$20.00 per hour)……………………$ 10Actual output………………………………………* 2,000Total standard direct labor cost………….. 20,000

Direct Labor Variances

To measure difference of actual and budgeted amount of direct labor two variance cumulate: Direct Labor Rate Variance Direct Labor Efficiency Variances

Direct Labor Rate Variance: Formula:

Direct labor rate variance=AH(AR-SR)Where AH=Actual hours used

AR= Actual rate per hour SR= Standard rate per hour

Direct Labor Variances Example cont..

As given in data Direct Labor: actual cost 980 hourat$21 per hour Direct labor rate variance =AH(AR-SR)

=980($21-20) =$980

Unfavorable

Direct Labor Efficiency Variance: Formula:

Direct Labor Efficiency Variance =SR(AH-SH)

Where SR = Standard rateAH= Actual hour usedSH= Standard hours

allowed

Direct Labor Variances Example cont..

Direct labor efficiency variance = SR(AH - SH)

= $20(980-1000)

=$400 favorable

It also may be favorable or unfavorable: The interpretation of unfavorable direct-labor

efficiency variances that more labor was used to accomplish a given task than was required in accordance with standards.

A favorable variance has opposite interpretation.

Direct Labor Variances Direct Labor variance is sum of Direct labor

rate and efficiency variance.Direct Labor Rate Variance………$980 unfavorableDirect Labor Efficiency Variance.. 400 favorableDirect Labor Variance…………… $580 unfavorable

% of variances = amount of variance *100

standard cost Efficiency Variance on Actual Output:

The number of standard hours of direct labor allowed is based on the actual production output. It would not be meaningful to compare standard or budgeted labor usage at one level of output with the actual hours used at a different level of output.

Thank You