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CHAPTER

STANDARD COSTING AND VARIANCE ANALYSIS


Learning Objectives

After reading and studying Chapter 7, you should be able to answer the following questions: 1. How are material, labor, and overhead standards set? . How are material, labor, and overhead varian!es !al!ulated and re!orded? ". #hy are standard !ost systems used? $. How have the setting and use of standards !hanged over time? %. How does the use of a single !onversion element &rather than the traditional labor and overhead elements' affe!t standard !osting? (. &Appendi)' How are varian!es affe!ted by multiple material and labor !ategories?

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Terminology Bill of materials: a do!ument that !ontains spe!ifi!ations for materials, in!luding quality and quantity Budget variance: the differen!e between total a!tual overhead and budgeted overhead based on standard hours allowed for the produ!tion a!hieved during the period Controllable variance: the budget varian!e of the two/varian!e approa!h to analy0ing overhead varian!es1 it is so named be!ause managers are able to e)ert influen!e on this amount during the short run Expected standard: e)pe!ted !ost or result1 e)pe!ted standards anti!ipate and allow for future waste and ineffi!ien!ies and therefore are not of signifi!ant value for motivation, !ontrol, or performan!e evaluation Fixed overhead spending variance: the differen!e between the total a!tual fi)ed overhead and budgeted fi)ed overhead1 this amount normally represents the pri!e varian!e for multiple fi)ed overhead !omponents deal standards: standards that provide for no ineffi!ien!ies of any type &e.g., normal operating delays and human limitations su!h as fatigue, boredom, or misunderstanding'1 ideal standards are impossible to attain on a !ontinuous basis and should not be used in motivating wor2ers or determining their performan!e levels Labor efficiency variance: in terms of hours, the differen!e between a!tual hours wor2ed for the period and the standard hours allowed for the a!tual output a!hieved1 in terms of !osts, &a!tual hours wor2ed for the period / standard hours allowed for the a!tual output' ) the standard labor rate Labor mix variance: the finan!ial effe!t asso!iated with !hanging the proportionate amount of higher or lower paid wor2ers in produ!tion1 it !an also be !omputed as &standard mi) ) a!tual hours ) standard rate' minus &a!tual mi) ) a!tual hours ) standard rate' Labor rate variance: the differen!e between the a!tual wages paid for total hours wor2ed and the standard wages for hours wor2ed1 it !an also be !omputed as &a!tual labor rate / standard labor rate' ) total a!tual hours wor2ed during the period Labor yield variance: the monetary impa!t of using a higher or lower number of hours than the standard allowed1 it !an be !omputed as &standard mi) ) standard hours ) standard rate' minus &standard mi) ) a!tual hours ) standard rate' !anagement by exception: a pra!ti!e whereby managers investigate only those pro!esses, !osts, varian!es, or other items of interest that deviate from e)pe!tation !aterial mix variance: the effe!t of substituting a nonstandard mi) of materials during the produ!tion pro!ess1 it !an also be !omputed as &standard mi) 3 a!tual quantity 3 standard pri!e' minus &a!tual mi) 3 a!tual quantity 3 standard pri!e' !aterial price variance: the differen!e between the amount a!tually paid for material and the standard pri!e of the material1 it !an also be !omputed as &a!tual pur!hase pri!e per unit of material / standard pur!hase pri!e per unit of material' ) the a!tual number of units pur!hased

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!aterial "uantity variance: in terms of units of material, the differen!e between the a!tual quantity of material used and the standard quantity allowed for the a!tual output a!hieved1 in terms of !ost, &a!tual quantity of materials used / standard quantity allowed' ) standard pri!e of material !aterial yield variance: the differen!e between the a!tual total quantity of input and the standard total quantity allowed based on output1 this differen!e refle!ts standard mi) and standard pri!es1 it !an be !omputed as &standard mi) 3 standard quantity 3 standard pri!e' minus &standard mi) 3 a!tual quantity 3 standard pri!e' !ethods#time measurement: an industrial engineering pro!ess that analy0es wor2 tas2s to determine the time a trained wor2er requires to perform a given operation at a rate that !an be sustained for an eight/hour wor2day !ix: any possible !ombination of material or labor inputs $oncontrollable variance: the fi)ed overhead varian!e due to !apa!ity utili0ation &i.e., volume'1 it !an also be !omputed as applied fi)ed overhead minus budgeted fi)ed overhead Operations flo% document: a do!ument listing all operations ne!essary to produ!e one unit of produ!t &or perform a spe!ifi! servi!e' and the !orresponding time allowed for ea!h operation Overhead efficiency variance: a varian!e !onsisting solely of variable overhead, it is the differen!e between total budgeted overhead at the a!tual a!tivity level and total budgeted overhead at the standard a!tivity level under the three varian!e approa!h1 it !an also be !omputed as budgeted overhead based on standard input quantity allowed minus budgeted overhead based on a!tual input quantity used Overhead spending variance: the differen!e between the a!tual overhead and total budgeted overhead at the a!tual a!tivity level under the three/varian!e approa!h1 it is the sum of the variable and fi)ed overhead spending varian!es of the four/varian!e approa!h &ractical standard: a standard that !an be rea!hed or slightly e)!eeded with reasonable effort by wor2ers1 it allows for normal, unavoidable time problems or delays su!h as ma!hine downtime and wor2er brea2s1 it is often believed to be most effe!tive in motivating wor2ers and determining performan!e levels 'tandard: the e)pe!ted !osts and quantities needed to manufa!ture a single unit of produ!t or perform a single servi!e 'tandard cost card: a do!ument that summari0es the standard quantities and !osts for dire!t material, dire!t labor, and overhead needed to !omplete one unit of produ!t 'tandard "uantity: the standard input quantity that should have been needed to a!hieve a given output Total cost of o%nership: the dire!t pur!hase pri!e of an input plus freight7duty7ta) !harges, payment and dis!ount terms, inventory storage !osts, s!rap rates, rebates or spe!ial in!entives, warranties, and disposal !osts Total overhead variance: the differen!e between total a!tual overhead and total applied overhead1 it is the amount of underapplied or overapplied overhead Total variance: the differen!e between total a!tual !ost in!urred and total standard !ost applied to the output of the period

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(ariable overhead efficiency variance: the differen!e between budgeted variable overhead for a!tual hours and standard variable overhead1 this varian!e quantifies the effe!t of using more or less overhead/ based inputs &e.g., labor hours, ma!hine hours' than the standard allowed for the produ!tion a!hieved1 it !an also be !omputed as &standard hours 8 a!tual hours' ) hourly variable overhead rate (ariable overhead spending variance: the differen!e between total a!tual variable overhead and the budgeted variable overhead based on a!tual hours1 it !an also be !omputed as budgeted variable overhead for a!tual hours 8 a!tual variable overhead for the period (ariance analysis: the pro!ess of !ategori0ing the nature &favorable or unfavorable' of the differen!es between standard and a!tual !osts and determining the reasons for those differen!es (olume variance: a fi)ed overhead varian!e that represents the differen!e between budgeted fi)ed overhead and fi)ed overhead applied to produ!tion1 it is also referred to as the non!ontrollable varian!e1 this varian!e is !aused solely by produ!ing at a level that differs from that used to !ompute the predetermined overhead rate whi!h in!orre!tly treats fi)ed overhead as a variable !ost1 it !an also be !omputed under three/varian!e analysis as applied fi)ed overhead minus budgeted fi)ed overhead )ield &or pro!ess yield': the output quantity that results from a spe!ified input

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Lecture Outline LO*+: ,o% are material- labor- and overhead standards set. A. -ntrodu!tion 1. 9eneral a. :rgani0ations develop and use standards for almost all tas2s. b. ;e!ause of the variety of organi0ational a!tivities and information ob<e!tives, no single standard !osting system is appropriate for all situations. !. =his !hapter dis!usses a traditional standard !ost system that provides pri!e and quantity standards for ea!h manufa!turing !ost !omponent and e)plains how standards are developed and illustrates the information that !an be gained from performing a detailed varian!e analysis.

;. >evelopment of a +tandard Cost +ystem 1. 9eneral a. A standard is a performan!e ben!hmar2 or norm used for planning and !ontrol purposes. 'tandards spe!ify the e)pe!ted !osts and quantities needed to manufa!ture a single unit of produ!t or perform a single servi!e. b. A standard cost system is a produ!t !osting system that determines produ!t !ost by using standards or norms for quantities and7or pri!es of !omponent elements1 it allows a!tual !osts to be !ompared against norms for !ost !ontrol purposes. i. >eveloping a standard !ost involves <udgment and pra!ti!ality in identifying material and labor types, quantities, and pri!es as well as an understanding of the types of organi0ational overhead !osts and how they behave. A primary ob<e!tive in manufa!turing a produ!t is to minimi0e unit !ost while a!hieving !ertain quality spe!ifi!ations.

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iii. After management has determined the input resour!es needed to a!hieve desired output quality at reasonable !ost, it !an develop quantity and pri!e standards. !. +tandards should be developed by a group, !omposed of representatives from the following areas: !ost a!!ounting, industrial engineering, human resour!es, data pro!essing, pur!hasing, and management.

d. =o ensure !redibility of the standards and to motivate people to operate as !lose to the standards as possible, standard/setting involvement of managers and wor2ers whose performan!e will be !ompared to standards is vital.

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. .aterial standards a. =he first step in developing material standards is to identify and list the spe!ifi! dire!t material !omponents used to manufa!ture the produ!t. ?our things must be 2nown about the materials inputs: i. ii. type of material needed1 quality &grade' of material needed1

iii. quantity of material needed1 and iv. pri!e per unit of material &must be based on level of quality spe!ified'. b. -n ma2ing quality de!isions, managers should remember that as the material grade rises, so generally does pri!e1 de!isions about material inputs usually see2 to balan!e the relationships of pri!e, quality, and pro<e!ted selling pri!es with !ompany ob<e!tives. !. =he bill of materials is a do!ument that !ontains spe!ifi!ations for materials, in!luding quality and quantity &+ee te)t Exhibit /#+'. i. ii. Companies often ma2e allowan!es for normal waste of !omponents. @ur!hasing agents should be aware of !ompany pur!hasing habits and of alternative suppliers and su!h information should be in!orporated into pri!e standards.

d. 6ather than !onsidering only the dire!t pur!hase pri!e of an input, pur!hasing agents now try to estimate and minimi0e the total cost of o%nership, whi!h in!ludes pri!e, freight7duty7ta) !harges, payment and dis!ounts terms, inventory storage !osts, s!rap rates, rebates or spe!ial in!entives, warranties, and disposal !osts. e. #hen all quantity and pri!e information is available, !omponent quantities are multiplied by unit pri!es to obtain the total !ost of ea!h !omponent. =hese totals are summed to determine the total standard material !ost of one unit of produ!t. ". 5abor +tandards a. =he development of labor standards requires the same basi! pro!edures as those used for materials. b. Aa!h produ!tion operation performed by wor2ers or by ma!hinery should be identified. i. !. All unne!essary movements of wor2ers and of material should be disregarded when time standards are set.

=o develop effe!tive standards, a !ompany must obtain quantitative information for ea!h produ!tion operation. !ethods#time measurement is an industrial engineering pro!ess that analy0es wor2 tas2s to determine the time a trained wor2er ta2es to perform a given operation at a rate that !an be sustained for an eight/hour wor2day.

d. After an analysis of labor tas2s is !ompleted, an operations flo% document !an be prepared whi!h lists all operations ne!essary to ma2e one unit of produ!t &or perform a spe!ifi! servi!e' and the !orresponding time allowed for ea!h operation. &+ee te)t Exhibit /# 0.' 4 *11 Cengage 5earning. All 6ights 6eserved. .ay not be s!anned, !opied or dupli!ated, or posted to a publi!ly a!!essible website, in whole or in part.

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e. 5abor rate standards should refle!t the wages paid to employees who perform the various produ!tion tas2s as well as the related employer !osts su!h as fringe benefits, ?-CA, and unemployment ta)es. i. f. A weighted average rate, !omputed as the total wage !ost per hour divided by the number of wor2ers, should be used if employees are paid different wage rates.

#hen time and rate information are available, <ob tas2 times are multiplied by wage rates to generate the total !ost of ea!h operation. =heses totals are summed to obtain the total standard labor !ost for one unit of produ!t.

$. :verhead standards a. :verhead should be assigned to separate !ost pools based on the !ost drivers, and allo!ations to produ!ts are made using various a!tivity drivers in order to provide the most appropriate !osting information. b. =he development of the bill of materials, operations flow do!ument, and predetermined overhead rates is followed by the preparation of a standard cost card, whi!h summari0es all standard quantities and !osts needed to !omplete one unit of produ!t. &+ee te)t Exhibit /#1.' !. ;oth a!tual and standard !osts are re!orded in a standard !ost system. ;ut standard !osts, rather than a!tual !osts, are !harged to the 6aw &>ire!t' .aterial, #or2 in @ro!ess, and ?inished 9oods -nventory a!!ounts with any differen!es between a!tual and standard !osts reported as varian!es.

LO*0: ,o% are material- labor- and overhead variances calculated and recorded. C. 9eneral ,arian!e Analysis .odel 1. 9eneral a. A total variance is the differen!e between total a!tual !ost for the produ!tion inputs and the total standard !ost applied to the produ!tion output: A!tual !ost of a!tual input 8 +tandard !ost of a!tual output b. =otal varian!es indi!ate differen!es between a!tual and e)pe!ted produ!tion !osts, but they do not provide useful information for determining why su!h differen!es o!!urred. =hus, total varian!es are subdivided into pri!e and usage varian!es in order to help managers a!!omplish their !ontrol ob<e!tives: i. A pri!e &or rate' varian!e refle!ts the differen!e between the a!tual pri!e &A@' paid for inputs and the standard input pri!e &+@' for the a!tual quantity &AB' of inputs used during the period: ii. @ri!e &or 6ate' ,arian!e C &A@ 8 +@'&AB'

A usage &quantity or effi!ien!y' varian!e shows the differen!e between the a!tual quantity &AB' of inputs used and the standard quantity &+B' of inputs allowed for the

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a!tual output a!hieved during the period. Esage varian!es fo!us on the effi!ien!y of resultsFthe relationship of inputs to outputs: !. Buantity &or Affi!ien!y' ,arian!e C &AB 8 +B' &+@'

=he standard "uantity 2'34 is the quantity of input that should have been used to a!hieve the a!tual output.

d. ,arian!es o!!ur when the a!tual pri!e or quantity amounts differ from standard. i. ,arian!es are labeled GunfavorableH if the a!tual pri!e or quantity amounts are higher than the standard pri!e or quantity amounts1 varian!es are labeled GfavorableH when the a!tual pri!e or quantity amounts are lower than the standard amounts. =he terms favorable and unfavorable do not ne!essarily equate to good and bad performan!e, respe!tively.

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iii. A total varian!e !an be !omputed for ea!h produ!tion !ost element &>., >5, :H'. >. .aterial and 5abor ,arian!e Computations 1. .aterial ,arian!es a. =e)t Exhibit /#5 presents the standard !ost !ard for a mountain bi2e made by +an<ay Corporation as well as a!tual !osts and quantities used. =his information is used in the te)t narrative to illustrate varian!e analysis. b. =he total material variance !an be subdivided into the material price variance and the material quantity variance: A@ 3 AB .aterial @ri!e ,arian!e +@ 3 AB .aterial Buantity ,arian!e =otal .aterial ,arian!e !. =he material price variance 2!&(4 indi!ates whether the amount paid for material was less than or more than standard pri!e. i. =his varian!e is usually the responsibility of the pur!hasing manager. +@ 3 +B

d. =he material "uantity variance 2!3(4 indi!ates whether the a!tual quantity used was less than or more than the standard quantity for the a!tual output a!hieved. i. =his varian!e is usually the responsibility of the produ!tion manager.

e. =he total material variance 2T!(4 is the summation of the individual varian!es or !an also be !al!ulated by subtra!ting the total standard !ost from the total a!tual !ost. f. @ri!e and quantity varian!e !omputations must be made for ea!h dire!t material !omponent and these !omponent varian!es are summed to obtain the total pri!e and quantity varian!es &although su!h a sum does not provide useful information for !ost !ontrol'.

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. @oint of @ur!hase .aterial ,arian!e .odel a. #hen the quantity of material pur!hased is not the same as the quantity of material pla!ed into produ!tion, the general varian!e model !an be easily modified to isolate material pri!e varian!es as early as possible to provide more rapid information for management !ontrol purposes. i. ;e!ause the material pri!e varian!e relates to the pur!hasing &rather than the produ!tion' fun!tion, the point of pur!hase model !al!ulates the material pri!e varian!e using the quantity of materials pur!hased &Bp' rather than the quantity of materials used &Bu'.

b. =he total material variance !an be subdivided into the material purchase price variance and the material price usage variance: A@ 3 AB@ +@ 3 AB@ .aterial @ri!e ,arian!e +@ 3 AB E +@ 3 +B

.aterial Buantity ,arian!e !. =he material purchase price variance is the materials pri!e varian!e when !omputed based on the quantity of materials pur!hased during the period rather than the quantity of materials used.

d. =he material quantity variance is the material usage varian!e when !omputed based on the quantity of materials used during the period. e. Jote that be!ause the pri!e and quantity varian!es have been !omputed using different bases, they should not be summed to determine a total material varian!e under this method. ". 5abor ,arian!es a. =he total labor variance !an be subdivided into the labor rate variance and the labor efficiency variance. A@ 3 AB 5abor 6ate ,arian!e +@ 3 AB 5abor Affi!ien!y ,arian!e =otal 5abor ,arian!e b. =he labor rate variance 2L6(4 is the differen!e between the a!tual wages paid to labor for the period and the standard !ost of a!tual hours wor2ed. !. =he labor efficiency variance 2LE(4 indi!ates whether the amount of time wor2ed was less than or more than the standard quantity for the a!tual output. +@ 3 +B

d. =he total labor variance is the summation of the individual varian!es or !an also be !al!ulated by subtra!ting the total standard !ost from the total a!tual !ost. 4 *11 Cengage 5earning. All 6ights 6eserved. .ay not be s!anned, !opied or dupli!ated, or posted to a publi!ly a!!essible website, in whole or in part.

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e. Jote that be!ause the rate and effi!ien!y varian!es have been !omputed using the same base &a!tual hours', they may be summed to determine a total labor varian!e. A. :verhead ,arian!es 1. :verhead ,arian!es a. ;e!ause total variable overhead !hanges in dire!t relationship with !hanges in a!tivity and fi)ed overhead per unit !hanges inversely with !hanges in a!tivity, a spe!ifi! !apa!ity level must be sele!ted to !ompute budgeted overhead !osts and to develop a predetermined overhead &:H' rate. i. Capacity refers to any measure of a!tivity. =he most !ommon !apa!ity measures are theoreti!al !apa!ity, pra!ti!al !apa!ity, normal !apa!ity, and e)pe!ted !apa!ity.

b. -f the !ompany uses separate variable and fi)ed overhead appli!ation rates, separate pri!e and usage !omponents are !al!ulated for ea!h type of overhead. =his four/varian!e approa!h provides managers the greatest detail and, thus, the greatest fle)ibility for !ontrol and performan!e evaluation. . ,ariable :verhead a. =he total variable overhead variance is the differen!e between a!tual variable overhead !osts in!urred for the period and standard variable overhead !ost applied to the periodKs a!tual produ!tion or servi!e output. A!tual ,:H A@ 3 AB ;udgeted ,:H &for a!tual a!tivity' +@ 3 AB Applied ,:H &for standard quantity allowed' +@ 3 +B

,:H +pending ,arian!e

,:H Affi!ien!y ,arian!e

=otal ,:H ,arian!e &Enderapplied or :verapplied ,:H' b. =he variable overhead spending variance is the differen!e between total a!tual variable overhead and the budgeted amount of variable overhead based on a!tual hours1 it is !aused by both !omponent pri!e and volume differen!es. i. ii. !. ,ariable overhead spending varian!es asso!iated with pri!e differen!es !an o!!ur be!ause, over time, !hanges in ,:H pri!es have not been in!luded in the standard rate. ,ariable overhead spending varian!es asso!iated with quantity differen!es !an be !aused by waste or shrin2age of produ!tion inputs &su!h as indire!t material'.

=he variable overhead efficiency variance is the differen!e between budgeted variable overhead based on a!tual hours and variable overhead applied based on standard hours allowed for the produ!tion a!hieved. i. =his varian!e quantifies the effe!t of using more or less of the a!tivity or resour!e whi!h is the base for variable overhead appli!ation. #hen a!tual input e)!eeds standard input allowed, produ!tion operations are !onsidered to be ineffi!ient. A)!ess input also

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indi!ates that an in!reased ,:H budget is needed to support the additional a!tivity base being used.

". ?i)ed :verhead a. =he total fixed overhead variance is the differen!e between a!tual fi)ed overhead !osts in!urred and standard fi)ed overhead !ost applied to the periodKs a!tual produ!tion. A!tual ?:H ;udgeted ?:H Applied ?:H &for standard quantity allowed' +@ 3 +B ,olume ,arian!e

?:H +pending ,arian!e

=otal ?:H ,arian!e &Enderapplied or :verapplied ?:H'

b. =he left !olumn is simply the total a!tual fi)ed overhead in!urred. =he middle !olumn, budgeted ?:H, is a !onstant amount throughout the relevant range of a!tivity and was the amount used to developed the predetermined ?:H rate1 thus, this amount is a !onstant figure regardless of the a!tual quantity of input or the standard quantity of input allowed. =he right !olumn is the amount of fi)ed overhead applied to produ!tion based on the standard fi)ed overhead rate and standard quantity allowed. !. =he fixed overhead spending variance is the differen!e between the total a!tual fi)ed overhead and budgeted fi)ed overhead. i. =his varian!e amount normally represents the differen!es between budgeted and a!tual !osts for the numerous ?:H !omponents, although it !an also refle!t resour!e mismanagement.

d. =he fi)ed overhead volume variance is the differen!e between budgeted and applied fi)ed overhead. i. Although !apa!ity utili0ation is !ontrollable to some degree, the volume varian!e is the one over whi!h managers have the least influen!e and !ontrol, espe!ially in the short run and for that reason the volume varian!e is also !alled the noncontrollable variance* =he volume varian!e merely translates under/or/over/utili0ation into a dollar amount. An unfavorable volume varian!e indi!ates less/than/e)pe!ted utili0ation of !apa!ity. -f available !apa!ity is !ommonly being used at a level higher &or lower' than that whi!h was anti!ipated or is available, managers should investigate and initiate appropriate a!tion.

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$. Alternative :verhead ,arian!e Approa!hes a. A four/varian!e approa!h !an be used only if the a!!ounting system distinguishes between variable and fi)ed !osts.

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b. =he total overhead variance is the differen!e between total a!tual overhead and total applied overhead, and is the only varian!e !omputed under the one-variance approach:

A!tual :verhead &,ariable :H L ?i)ed :H' =otal :verhead ,arian!e

Applied :verhead &+@ 3 +B'

!.

A middle !olumn representing budgeted overhead based on standard quantity is inserted between total actual overhead and total applied overhead under the two-variance approach: ;udgeted :H &for standard quantity' ,olume ,arian!e &or Jon!ontrollable ,arian!e' Applied :H +@ 3 +B

A!tual :verhead &,ariable :H L ?i)ed :H' ;udget ,arian!e &or Controllable ,arian!e'

=otal :verhead ,arian!e i. =he budget variance is the differen!e between total a!tual overhead and budgeted overhead based on standard hours allowed for the produ!tion a!hieved1 it is !omputed as part of the two/varian!e analysis1 it is also referred to as the controllable variance. =he volume variance !an be !omputed under the four/varian!e, three/varian!e, or two/ varian!e analysis.

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d. A !olumn representing budgeted overhead based on actual hours is inserted immediately to the right of total actual overhead under the three-variance approach: A!tual :verhead &,:H L ?:H' :verhead +pending ,arian!e ;udgeted :verhead &for a!tual input used' :verhead Affi!ien!y ,arian!e =otal :verhead ,arian!e i. =he overhead spending variance is the differen!e between total actual overhead and total budgeted overhead at actual input activity1 thus, a fle)ible budget is required. -t is !omputed as part of the three-variance analysis1 it is equal to the sum of the variable and fi)ed overhead spending varian!es. ;udgeted :verhead &for a!tual output' :verhead ,olume ,arian!e Applied :verhead &+@ 3 +B'

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ii.

=he overhead efficiency variance is the differen!e between total budgeted overhead at actual input activity and total budgeted overhead at standard input allowed &output a!tivity'1 it is !omputed as part of the three-variance analysis1 it is the same as variable overhead efficiency variance.

e. =e)t Exhibit /#7 shows the interrelationships of overhead varian!es. ?. +tandard Cost +ystem Mournal Antries 1. +tandard !ost system <ournal entries are presented in te)t Exhibit /#8* . Jote that unfavorable varian!es have debit balan!es while favorable varian!es have !redit balan!es. ". Although standard !osts are useful for internal reporting, they !an be used in finan!ial statements only if the amounts are substantially equivalent to those that would have resulted from using an a!tual !ost system. $. At year/end, ad<usting entries are made to eliminate standard !ost varian!es. =he entries depend on whether the varian!es are, in total, insignifi!ant or signifi!ant. a. -f insignifi!ant, unfavorable varian!es are !losed as debits to Cost of 9oods +old1 favorable varian!es are !redited to Cost of 9oods +old. b. -f signifi!ant, varian!es are prorated at year/end among ending inventories and Cost of 9oods +old so that the balan!es in those a!!ounts appro)imate a!tual !osts. i. @roration is based on the relative si0e of the a!!ount balan!es as illustrated in the e)ample provided in the te)t narrative.

LO*1: 9hy are standard cost systems used. 9. #hy +tandard Cost +ystems are Esed 1. Cleri!al effi!ien!yFa !ompany that uses standard !osts to tra!e the flow of !osts through its a!!ounting system usually dis!overs that less !leri!al time and effort are required than in an a!tual !ost system. . .otivationFstandards represent a te!hnique of !ommuni!ating managementKs e)pe!tations of effi!ien!y to wor2ers. ". @lanningFmanagers !an use !urrently available standard !osts to estimate future quantities and !osts. $. ControllingFthe !ontrol pro!ess begins with the establishment of standards whi!h provide a basis against whi!h a!tual !osts !an be measured so varian!es may be !omputed. a. (ariance analysis is the pro!ess of !ategori0ing the nature &favorable or unfavorable' of the differen!es between standard and a!tual !osts and determining the reasons for those differen!es. b. =he setting of upper and lower toleran!e limits for deviations allows managers to implement the management by exception !on!ept. &+ee te)t Exhibit /#/.' 4 *11 Cengage 5earning. All 6ights 6eserved. .ay not be s!anned, !opied or dupli!ated, or posted to a publi!ly a!!essible website, in whole or in part.

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%. >e!ision ma2ingFstandard !ost information availability fa!ilitates many de!isions. (. @erforman!e evaluationFsummary varian!e reports fo!us attention on the operating performan!e of subordinate managers, allowing top managers to determine when !osts were and were not !ontrolled by whi!h managers. =op management !an then provide vital feedba!2 to the subordinate managers. H. Considerations in Astablishing +tandards 1. Appropriateness a. Appropriateness and attainability need to be !onsidered when standards are established. i. Appropriateness, in relation to a standard, refers to the basis on whi!h the standards are developed and how long they are e)pe!ted to last.

b. +tandards are developed from past and !urrent information, and they should refle!t te!hni!al and environmental fa!tors e)pe!ted during the period in whi!h the standards are to be applied. !. ?a!tors su!h as the materials quality, normal ordering quantities of materials, e)pe!ted employee wage rates, degree of plant automation, fa!ility layout, and mi) of employee s2ills should be !onsidered.

d. +tandards must evolve over the organi0ationKs life to refle!t its !hanging methods and pro!esses. . Attainability a. Attainability refers to managementKs belief about the degree of diffi!ulty or rigor that should be in!urred in a!hieving the standard. +tandards !an be !lassified by their degree of rigor and, thus, their motivational value from easy to diffi!ult as follows: e)pe!ted, pra!ti!al, and ideal. b. Expected standards are standards set at a level that refle!ts what is a!tually e)pe!ted to o!!ur in the future period1 these standards anti!ipate future wastes and ineffi!ien!ies and allow for them1 they are not of signifi!ant value for !ontrol and performan!e evaluation purposes. !. &ractical standards are standards that !an be rea!hed or slightly e)!eeded appro)imately (* to 7* per!ent of the time with reasonable effort by wor2ers1 they allow for normal, unavoidable time problems or delays and for wor2er brea2s1 they are believed to be most effe!tive in indu!ing the best performan!e from wor2ers, sin!e su!h standards represent an attainable !hallenge. deal standards are standards that provide for no ineffi!ien!ies of any type, are impossible to attain, and are sometimes !alled theoreti!al standards.

d.

LO* 5: ,o% have the setting and use of standards changed over time. -. Changes in +tandards Esage 1. Ese of -deal +tandards and =heoreti!al Capa!ity

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a. .any a!!ountants and business people believe that in!orre!t measurements are sometimes employed in utili0ing varian!es for !ontrol and performan!e evaluation purposes. b. =he Mapanese philosophy is a notable e)!eption to the pra!ti!e of not using ideal or theoreti!al standards for performan!e evaluation. i. !. =he <ust/in/time &M-=' produ!tion system and total quality management &=B.' !on!epts both have goals of 0ero defe!ts, 0ero ineffi!ien!y, and 0ero downtime.

-deal standards be!ome e)pe!ted standards under su!h a system, and there is no &or only minimal' level of a!!eptable deviation from standard.

d. -mplementing ideal standards requires that employees !ommuni!ate and wor2 together to improve performan!e: i. ii. Current problems must be identified and their !auses must be pinpointed. .anagement must be willing to invest in those plant and equipment items, equipment rearrangements, wor2er training and7or pay in!reases, vendor !hanges, and so on that will ma2e it possible to a!hieve ideal standards.

iii. =raining is essential if wor2ers are to perform at high levels of effi!ien!y. e. +etting standards at the ideal level in part assigns the responsibility for quality to wor2ers. i. ii. f. =hus, management must empower wor2ers with the authority to rea!t effe!tively to problems sin!e management has delegated the responsibility for quality to the wor2ers. .anagement must provide rewards for a!hievement sin!e people are required to wor2 at their ma)imum potential.

=he pro!ess of implementing ideal standards is illustrated in te)t Exhibit /#:.

g. #orld/!lass !ompanies !an also use theoreti!al !apa!ity to set fi)ed overhead rates. i. ii. +u!h a !apa!ity measure would provide the lowest and most appropriate predetermined :H rate. Any underapplied :H resulting from a differen!e between theoreti!al and a!tual !apa!ity would indi!ate !apa!ity that should be either used or eliminated or it !ould indi!ate human !apabilities that have not been fully developed.

iii. Any end/of/period underapplied :H would be viewed as a period !ost and !losed to a loss a!!ount to attra!t managerial attention to the ineffi!ient and ineffe!tive use of resour!es. h. +tandards are slowly moving away from the pra!ti!al and !loser to the ideal in order for Ameri!an !ompanies to !ompete in global mar2ets. . Ad<usting +tandards a. +tandards were traditionally set and retained for at least one year.

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b. =he !urrent business environment !hanges so swiftly that a standard might not be useful for management !ontrol purposes during the entire year. !. .anagement !an either de!ide to ignore su!h !hanges or to in!orporate the !hanges in the standard. Changing the standards to refle!t the !hanges in pri!es or quantities would ma2e some aspe!ts of management !ontrol and performan!e evaluation more effe!tive and others more diffi!ult.

d. .anagement may also !onsider the original standards to be Gfro0enH for budget purposes and prepare a revised budget using the new !urrent standards. i. A !ombined Gfro0enH and revised budget system is depi!ted in te)t Exhibit /#;.

". .aterial @ri!e ,arian!e ;ased on @ur!hases 6ather than Esage a. =he material pri!e varian!e !al!ulation has usually been based on pur!hases rather than on usage. b. =he varian!e is !omputed as qui!2ly as possible relative to the in!urren!e of !ost. !. +u!h varian!e !al!ulation at the point of pur!hase does allow the manager to measure the impa!t of buying de!isions more rapidly, but may not be relevant in a M-= environment.

d. A material pri!e varian!e !omputation based on pur!hases may lessen the probability of re!ogni0ing a relationship between a favorable material pri!e varian!e and an unfavorable material quantity varian!e. $. >e!line in >ire!t 5abor a. =he ne!essity for dire!t labor varian!e !al!ulations will be minimi0ed as the per!entage of total produ!t !ost represented by dire!t labor !ost de!lines. b. >ire!t labor !ost may be!ome a small part of a !onversion !ost !ategory. !. An in!rease in automation often relegates labor to an indire!t !ategory sin!e wor2ers be!ome ma!hine overseers rather than produ!t produ!ers.

LO*7: ,o% does the use of a single conversion element 2rather than the traditional labor and overhead elements4 affect standard costing. M. Conversion Cost as an Alement in +tandard Costing 1. >ire!t labor !ost usually represents an e)tremely small part of total produ!t !ost in highly automated fa!tories. a. :ne wor2er may oversee a large number of ma!hines and deal mainly with trouble/shooting ma!hinery malfun!tions. b. =he wor2erKs wages may be more !losely related to indire!t labor rather than to dire!t labor. . .any !ompanies have responded to overhead !osts being so mu!h larger than dire!t labor !osts by adapting their standard !ost systems to provide for only two elements of produ!t !ost: dire!t material and !onversion. 4 *11 Cengage 5earning. All 6ights 6eserved. .ay not be s!anned, !opied or dupli!ated, or posted to a publi!ly a!!essible website, in whole or in part.

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a. Conversion !osts are li2ely to be separated into their variable and fi)ed !omponents. b. Conversion !osts are also li2ely to be separated into dire!t and indire!t !ategories based on their ability to be tra!ed to a ma!hine rather than to a produ!t. ". ,arian!e analysis for !onversion !ost in automated plants usually fo!uses on: a. +pending varian!es for overhead !osts1 b. Affi!ien!y varian!es for ma!hinery and produ!tion !osts rather than labor !osts1 and !. ,olume varian!e for produ!tion.

$. -n automated systems, managers are better able to !ontrol not only the spending and effi!ien!y varian!es but also the volume varian!e. %. =he analysis is similar to the traditional three/varian!e overhead approa!h. a. +ee te)t Exhibit /#+< for an illustration of varian!e analysis under a !onversion !ost approa!h. LO*8: 2=ppendix4 ,o% are variances affected by multiple material and labor categories. N. .i) and Oield ,arian!es 1. .i) and Oield ,arian!es a. A mix is any possible !ombination of materials or labor inputs. b. A yield is the quantity of output that results from a spe!ified input. !. =e)t Exhibit /#++ provides standard and a!tual information for an e)ample dis!ussed in the te)t narrative.

. .aterial @ri!e, .i), and Oield ,arian!es a. A material pri!e varian!e shows the dollar effe!t of paying pri!es that differ from the raw material standard.

b. =he material mix variance measures the monetary effe!t of substituting a nonstandard mi) of materials1 &a!tual mi) 3 a!tual quantity 3 standard pri!e' minus &standard mi) 3 a!tual quantity 3 standard pri!e'. !. =he material yield variance is the differen!e between the a!tual total quantity of input and the standard total quantity allowed based on output and uses standard mi) and standard pri!es to determine varian!e1 &standard mi) 3 a!tual quantity 3 standard pri!e' minus &standard mi) 3 standard quantity 3 standard pri!e'.

d. =e)t Exhibit /#+0 presents the !omputations for the material varian!es. ". 5abor 6ate, .i), And Oield ,arian!es

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a. =he labor mix variance presents the finan!ial effe!t asso!iated with !hanging the proportionate amount of higher or lower paid wor2ers in produ!tion1 &a!tual mi) 3 a!tual hours 3 standard rate' minus &standard mi) 3 a!tual hours 3 standard rate'. b. =he labor yield variance shows the monetary impa!t of using more or fewer total hours than the standard allowed1 &standard mi) 3 a!tual hours 3 standard rate' minus &standard mi) 3 standard hours 3 standard rate'. !. =e)t Exhibit /#+1 presents the !omputations for the labor varian!es.

$. ;e!ause there are trade/offs in mi) and yield when !omponent qualities and quantities are !hanged, management should observe the integrated nature of pri!e, mi), and yield. a. =he effe!ts of !hanges of one element on the other two need to be !onsidered for managing !ost effi!ien!y and output quality. b. -f mi) and yield !an be in!reased by substituting less e)pensive resour!es while maintaining quality, then the standards and proportions of !omponents should be !hanged. !. -f !osts are redu!ed but quality is maintained, selling pri!es may be redu!ed to gain a larger mar2et share.

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!ultiple Choice 3uestions 1. &5:.1' +ele!t the !orre!t statement regarding standards. a. A standard is a ben!hmar2 or norm used for planning and !ontrol. b. =he differen!e between standard !ost and a!tual !ost is referred to as a varian!e. !. +tandards are developed for materials, labor, and overhead. d. All of the above . &5:.1' =he do!ument that summari0es the e)pe!ted quantities and !osts needed to produ!e a unit is !alled a a. bill of materials. b. total !ost of ownership do!ument. !. operations flow do!ument. d. standard !ost !ard. ". &5:. ' =his month 6 Company planned to produ!e ",*** units of its produ!t. =he standard !ost !ard !alls for si) pounds of material at P."* per pound. A!tual produ!tion for the month was ",1** units, resulting in a favorable pri!e varian!e of P"D* and an unfavorable quantity varian!e of P1 *. ;ased on these varian!es, one !ould !on!lude that: a. more materials were pur!hased than were used. b. the a!tual !ost of material was less than the standard !ost. !. the a!tual usage of material was less than the standard allowed. d. the a!tual !ost and usage of material were both less than standard. $. &5:. ' An unfavorable dire!t labor effi!ien!y varian!e !ould be !aused by a &n': a. unfavorable variable overhead spending varian!e. b. unfavorable fi)ed overhead volume varian!e. !. unfavorable material usage varian!e. d. favorable fi)ed overhead volume varian!e. %. &5:. ' =he fle)ible budget for the month of August was for I,*** units with dire!t material at P1% per unit. >ire!t labor was budgeted at $% minutes per unit for a total of PD1,***. A!tual output for the month was D,%** units with P1 7,%** in dire!t material and P77,77% in dire!t labor e)pense. >ire!t labor hours of (,"7% were a!tually wor2ed during the month. ,arian!e analysis would show: a. a favorable dire!t labor effi!ien!y varian!e of P1, 7%. b. an unfavorable dire!t labor effi!ien!y varian!e of P1, 7%. !. an unfavorable dire!t labor rate varian!e of P1, 7%. d. none of the above. (. &5:. ' =he total fi)ed overhead varian!e is the: a. measure of the lost profits from the la!2 of sales volume. b. amount of the underapplied or overapplied fi)ed overhead !osts. !. potential !ost redu!tion that !an be a!hieved from better !ost !ontrol. d. measure of produ!tion ineffi!ien!y. 7. &5:. ' ,ariable overhead is applied on the basis of standard dire!t labor hours. -f the dire!t labor effi!ien!y varian!e is favorable, the variable overhead effi!ien!y varian!e will be: a. unfavorable. b. favorable. !. 0ero. d. the same amount as the labor effi!ien!y varian!e.

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D. &5:. ' O CompanyKs produ!t has a labor standard of hours per unit. ?or *11, it estimates its produ!tion will be **,*** units &$**,*** >5Hs'. -t budgets total overhead at PI**,***, whi!h results in a fi)ed overhead rate of P1.%* per hour. A!tual data for the year in!lude: A!tual produ!tion, 1ID,*** units &$$*,*** >5Hs', A!tual variable overhead, P"% ,***, A!tual fi)ed overhead, P%7%,*** =he variable overhead effi!ien!y varian!e for the year is: a. P((,*** unfavorable. b. P"%,% * favorable. !. P"",*** favorable. d. P"",*** unfavorable. I. &5:."' +tandard !ost systems should be used for all of the following reasons except: a. motivation. b. de!ision/ma2ing. !. establishing blame. d. !leri!al effi!ien!y. 1*. &5:."' +ele!t the !orre!t statement from the following. a. An e)tremely favorable varian!e is not ne!essarily a good varian!e. b. =here is a movement in pra!ti!e toward reporting varian!es less often than in the past. !. :nly unfavorable varian!es need to be investigated. d. ?or proper performan!e evaluation to be made, responsibility for varian!es should not be tra!ed to spe!ifi! managers. 11. &5:.$' =he best basis upon whi!h !ost standards should be set to measure !ontrollable produ!tion inefficiencies is: a. engineering standards based on attainable performan!e. b. normal !apa!ity. !. engineering standards. d. ideal !apa!ity. 1 . &5:.%' ,arian!e analysis for !onversion !ost in automated plants normally fo!uses on: a. spending varian!es for overhead !osts. b. effi!ien!y varian!es for ma!hinery and produ!tion !osts rather than labor !osts. !. volume varian!e for produ!tion. d. all of the above. 1". &5:.(' &Appendi)' A possible !ombination of materials or labor is !alled a. materials/time measurement. b. yield. !. mi). d. !onversion. 1$. &5:.(' &Appendi)' A measure of the differen!e between the a!tual total quantity of input and the standard total quantity allowed based on output is !alled the a. mi) varian!e. b. yield varian!e. !. volume varian!e. d. none of the above. 1%. &5:.(' &Appendi)' +ele!t the !orre!t equation for the labor mi) varian!e. a. &A!tual mi) ) A!tual hours ) A!tual rate' 8 &A!tual mi) ) A!tual hours ) +tandard rate' b. &A!tual mi) ) A!tual hours ) +tandard rate' 8 &A!tual mi) ) A!tual hours ) +tandard rate' !. &A!tual mi) ) A!tual hours ) +tandard rate' 8 &+tandard mi) ) A!tual hours ) +tandard rate' d. &+tandard mi) ) A!tual hours ) +tandard rate' 8 &+tandard mi) ) +tandard hours ) +tandard rate'

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!ultiple Choice 'olutions 1. . ". $. %. d d b ! ! +@ 3 AB P1 .** 3 (,"7% P7(,%** P1, 7% E 5abor 6ate ,arian!e P/*/ 5abor Affi!ien!y ,arian!e >+-0/7 ? =otal 5abor ,arian!e (. 7. D. b b d ?le)ible ;udget ;ased on -nput &+@ 3 AB' &P*.7% 3 $$*,*** 5Hs' P""*,*** &:utput .easure' &+@ 3 +B' &P*.7% 3 "I(,*** 5Hs' P I7,*** +@ 3 +B P1 .** 3 (,"7% P7(,%**

A@ 3 AB P1 . * 3 (,"7% P77,77%

>11-<<< ? ,:H I. 1*. 11. 1 . 1". 1$. 1%. ! a a d ! b !

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