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Chapter 7
Standard Costing and Variance Analysis
Cost AccountingFoundations and Evolutions
Kinney and RaibornSeventh Edition
COPYRIGHT © 2009 South-Western, a part of Cengage Learning. South-Western is a trademark used herein
under license.
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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
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Learning Objectives (2 of 2)
• Explain why standard cost systems are used
• Identify changes in the use of standards
• Contrast the traditional labor and overhead elements to a single conversion element
• (Appendix) Explain how multiple material and labor categories affect variances
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Standard Cost Systems
• Manufacturing
• Service
• Not-for-Profit
• Record standard and actual costs in the accounting records
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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
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Manufacturing Objective
Minimize unit cost while achieving certain quality specifications
Input Resource
s
OutputQuality
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Material Standards• Materials used
– Types– Quantity– Quality– Price
• From – Product specifications, observation, inquiry– Bill of materials
• Balance cost, quality, and projected sales price
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Material Standards
StandardMaterial = Unit Purchase Price x quantityCost
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Labor Standards• Labor used
– Types
• Production, setup, cleanup, and rework
– Quantity
– Cost • Include wages, payroll taxes, and fringe benefits
• From– Industrial engineering studies including methods-time
measurement (MTM), time and motion studies, historical data
– Operations flow document
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Labor Standards
Standard
Labor = Hours x Wage Rate
Cost
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Overhead Standards
• Variable and fixed manufacturing overhead
• Estimated level of activity
• Estimated costs
• Predetermined factory overhead application rates
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Standard Cost Card
For one unit of output (a bike)
Standard Direct Material Components
Standard Direct Labor Components
Manufacturing Overhead
Variable Overhead
Fixed Overhead
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Variance
Variance is the difference between an actual cost and
a standard cost
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Total VarianceTotal actual cost incurred minus
total standard cost applied to output produced
Standard cost of actual
production output
Actual price of actual
production input
Total Variance*
*Favorable or unfavorable
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SP x SQAP x AQ
Total Variance
Total Variance
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
Inputs Outputs
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Price Variance
AP x AQ SP x SQ
Total Variance
SP x AQ
Price/Rate Variance
(AP - SP) x AQ*
*Favorable or unfavorable
What was paid
What shouldhave been
paid
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Usage Variance
AP x AQ SP x SQ
Total Variance
SP x AQ
Usage Variance
(AQ - SQ) x SP*
*Favorable or unfavorable
What shouldhave been
used for the level of output
What wasused
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Material Price Variance (MPV)
AP x AQ SP x SQ
Total Variance
SP x AQ
MPV
(AP - SP) x AQ*
*Favorable or unfavorable
What was paid
What shouldhave been
paid
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Material Price Variance
• Calculate Material Price Variance at
– point of purchase, or
– when materials used
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Material Quantity Variance (MQV)
AP x AQ SP x SQ
Total Variance
SP x AQ
MQV
(AQ - SQ) x SP*
*Favorable or unfavorable
What shouldhave beenused for
level of output
What wasused
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Labor Rate Variance (LRV)
AP x AQ SP x SQ
Total Variance
SP x AQ
LRV
(AP - SP) x AQ*
*Favorable or unfavorable
What was paid
What shouldhave been
paid
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Labor Efficiency Variance (LEV)
AP x AQ SP x SQ
Total Variance
SP x AQ
LEV
(AQ - SQ) x SP*
*Favorable or unfavorable
What shouldhave beenused for
level of output
What wasused
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Overhead Variances
Variable Overhead
Actual variable overhead is total of various ledger accounts
SP = Predetermined variable overhead rate
Fixed Overhead
Actual fixed overhead is total of various ledger
accounts
SP = Predetermined fixed overhead rate
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Variable Overhead Variances
What should have beenused for level of output
For actual hoursused
VOH Spending Variance
VOH Efficiency Variance
Total VOH Variance
SP x SQSP x AQ
Actual VOH
Budgeted VOH
Applied VOH
Actual
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VOH Spending Variance
• Caused by price differences
– managers have little control over prices
• Caused by shrinkage or waste
– managers should be held accountable
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Fixed Overhead Variances
SP x SQ
Actual FOH
Budgeted FOH
Applied FOH
FOH Spending Variance
FOH Volume
Variance
Total FOH Variance
What should have beenused for level of output
ConstantAmount
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FOH Spending Variance
• Calculate variance for each component
• Caused by price differences
• May reflect mismanagement of resources
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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
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Alternative Overhead Variance Approaches
• One variance
• Two variance
• Three variance
• Four variance
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One Variance Approach
SP x SQ
Actual OH
Standard Cost of
OH
Total OH VarianceApplied
Overhead
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Two Variance Approach
SP x SQ
Actual OH
Budgeted OH based on Standard Quantity
Standard Cost of
OH
Budget Variance
Volume Variance
Total OH Variance Applied Overhead
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Three Variance Approach
SP x SQ
Actual OH
based on actual output
Standard OH
Volume Variance
Total OH Variance
Budgeted OHbased on
Actual Inputs
OH Spending Variance
OH Efficiency Variance
Applied Overhead
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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
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Purchase of Materials(Point of Purchase Method)
Materials Accts Pay
MaterialsPrice
Variance
Debit - Unfavorable
Credit - Favorable
AP x AQ purchased
SP x AQ purchased
U F
AtStandard
Cost
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Use of Materials
WIP Materials
MaterialsQuantityVariance
SP x AQ used
SP x SQ allowed
Debit - Unfavorable
Credit - Favorable
U F
AtStandard
Cost
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Record Labor
Wages Pay
Labor Efficiency Variance
AP x AQ
WIP
SP x SQ allowed
Labor Rate Variance
Debit - Unfavorable
Credit - Favorable
AtStandard
CostU F U F
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SP x SQ Allowed
Apply Overhead Throughout the Year
SP x SQ
Allowed
WIP FOHVOHSP x SQ
Allowed
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Year-End Treatment for VOH
Enter a debit
or credit to
bring balance
to zero
VOH Efficiency Variance
VOH Spending Variance
Debit - Unfavorable
Credit - Favorable
VOH
Actual Applied---------------
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Year-End Treatment for FOH
FOH Spending Variance
Volume Variance FOH
Actual Applied-------------
Enter a debit
or credit to
bring balance
to zero
Debit - Unfavorable
Credit - Favorable
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Year-End Treatment of Variances
Material Price Variance
• Raw Materials
• WIP
• Finished Goods
• Cost of Goods Sold
All other variances
• WIP
• Finished Goods
• Cost of Goods Sold
Immaterial - Adjust Cost of Goods SoldMaterial - Prorate variances to
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Why Use Standard Cost Systems
• Clerical efficiency
• Motivation
• Planning
• Controlling - variance analysis
• Decision making
• Performance evaluation
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Setting Standards
• Appropriateness
• Attainability
– Expected standards
– Practical standards
– Ideal standards
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Trends in Standards
• Ideal Standards and Theoretical Capacity
• Adjusting standards
• Price variance on purchase versus usage
• Decline in direct labor content
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Conversion Costs
• Combine direct labor and manufacturing overhead
• Variances– Spending variance for overhead– Efficiency variances for machinery and
production costs– Volume variances for production
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Material Mix and Yield VariancesAM xAQ xAP
AM xAQ xSP
SM xAQ xSP
SM xSQ xSP
MaterialPrice
Variance
MaterialMix
Variance
MaterialYield
Variance
What should have beenused for level of output
AM - Actual MixSM - Standard Mix
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Labor Mix and Yield VariancesAM xAH xAR
AM xAH xSR
SM xAH xSR
SM xSH xSR
LaborRate
Variance
LaborMix
Variance
LaborYield
Variance
What should have beenused for level of output
M - MixH - HoursR - Rate
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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?
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Potential Ethical Issues
• Setting high standards to create favorable variances
• Ignoring effects of one production area on another
• Setting overhead rates too low based on high production levels to distort inventory cost and operating income
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Potential Ethical Issues
• Producing inventory only to create a favorable volume variance
• Not updating standards so that favorable variances are created
• Using low quality materials or labor to create favorable variances and low quality products