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Chapter

STANDARD COST
SYSTEMS

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Learning
Learning Objective
Objective

To explain standard costs


and how they assist
managers in controlling
costs.

LO1
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Standard
Standard Cost
Cost Systems
Systems
Based on carefully
predetermined amounts.

Standard
Costs are

Used for planning labor, material


and overhead requirements.
The expected level
of performance.
Benchmarks for
measuring performance.

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Standard
Standard Cost
Cost Systems
Systems

Amount

A standard cost variance


is the amount by which
an actual cost differs from
the standard cost.
Standard cost

Direct
Labor

Direct
Material

Manufacturing
Overhead

Type of Product Cost


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Standard
Standard Cost
Cost Systems
Systems
This variance is
favorable because
the actual cost
is less than the
standard cost.

Amount

This variance is unfavorable


because the actual cost
exceeds the standard cost.

Standard cost

Direct
Labor

Direct
Material

Manufacturing
Overhead

Type of Product Cost


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Variance
Variance Analysis
Analysis
Identify
questions

Receive
explanations

Conduct next
periods
operations

Analyze
variances

Begin

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Take
corrective
actions

Prepare standard
cost performance
report

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Learning
Learning Objective
Objective
To explain the difference
between setting ideal
standards and setting
reasonably achievable
standards.

LO2
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Establishing
Establishing and
and Revising
Revising
Standard
Standard Costs
Costs
Should we use
normal standards
or ideal standards?

Engineer
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Normal standards should be


set at levels that are currently
attainable with reasonable and
efficient effort.

Production
manager

Managerial
Accountant
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Establishing
Establishing and
and Revising
Revising
Standard
Standard Costs
Costs
I agree. Ideal standards, that are
based on perfection, are
unattainable and therefore
discouraging to most employees.

Human
Resources
Manager
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Use
Use of
of Standard
Standard Costs
Costs in
in
Developing
Developing Budgets
Budgets

Are standards the


same as budgets?

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A standard is the
expected cost for one
unit.
A budget is the
expected cost for all
units.

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Direct
Direct Material
Material Standards
Standards
Price
Standards

Quantity
Standards

Use competitive
bids for the quality
and quantity desired.

Use product
design specifications.

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Direct
Direct Material
Material Standards
Standards
The standard material cost for one unit of product is:
standard price for
one unit of material

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standard quantity
of material
required for one
unit of product

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Direct
Direct Labor
Labor Standards
Standards
Rate
Standards

Time
Standards

Use wage
surveys and
labor contracts.

Use time and


motion studies for
each labor operation.

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Setting
Setting Direct
Direct Labor
Labor Standards
Standards
The standard labor cost for one unit of product is:
standard wage rate
for one hour

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standard number
of labor hours
for one unit
of product

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Manufacturing
Manufacturing Overhead
Overhead Standards
Standards
Rate
Standards

Activity
Standards

The rate is based


on an estimate of total
overhead at the normal
level of activity.

The activity is the


cost driver used to
calculate the overhead
rate.

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Manufacturing
Manufacturing Overhead
Overhead Standards
Standards
The standard overhead cost for one unit of product is:
standard variable
overhead rate for
one unit of
activity

standard number
of activity units
for one unit of
product

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A
A General
General Model
Model for
for
Variance
Variance Analysis
Analysis
Standard Cost Variances

Price Variance

Quantity Variance

The difference between


the actual price and the
standard price

The difference between


the actual quantity and
the standard quantity

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A
A General
General Model
Model for
for
Variance
Variance Analysis
Analysis
Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance

Standard Quantity

Standard Price

Quantity Variance

Standard price is the amount that should


have been paid for the resources acquired.

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A
A General
General Model
Model for
for
Variance
Variance Analysis
Analysis
Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance

Standard Quantity

Standard Price

Quantity Variance

Standard quantity is the quantity that should


have been used for the actual good output.

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Learning
Learning Objective
Objective

To compute direct materials


and direct labor
variances and explain
the meaning of each.

LO3
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Material
Material Price
Price and
and Quantity
Quantity
Variances
Variances
Actual Quantity

Actual Price

Actual Quantity

Standard Price

Price Variance
Materials
price
variance
AQ(AP
- SP)
Labor rate variance
AQ =Variable
Actual overhead
Quantity
AP = spending
Actual Price
variance
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Standard Quantity

Standard Price

Quantity Variance
Materials
quantity
variance
SP(AQ
- SQ)
Labor efficiency variance
SP
= Standard
Price
Variable
overhead
SQ
= Standard
Quantity
efficiency
variance

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Standard
Standard Costs
Costs and
and Variance
Variance
Analysis:
Analysis: An
An Illustration
Illustration

Zippy

Hanson
Hanson Inc.
Inc. has
has the
the following
following material
material standard
standard to
to
manufacture
manufacture one
one Zippy:
Zippy:
1.5
1.5 pounds
pounds per
per Zippy
Zippy at
at $4.00
$4.00 per
per pound
pound

Records
Records last
last week
week show
show 1,700
1,700 pounds
pounds of
of material
material
were
were purchased
purchased on
on May
May 10
10 at
at aa total
total cost
cost of
of
$6,630.
$6,630. The
The material
material was
was used
used to
to make
make 1,000
1,000
Zippies
Zippies that
that were
were completed
completed on
on May
May 15.
15.
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Material
Material Variances
Variances
Question
Question 11

Zippy

The
The actual
actual price
price per
per pound
pound paid
paid for
for
the
the material
material was
was
a.
a.
b.
b.
c.
c.
d.
d.

$4.00
$4.00 per
per pound.
pound.
$4.10
$4.10 per
per pound.
pound.
$3.90
$3.90 per
per pound.
pound.
$6.63
$6.63 per
per pound.
pound.

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Material
Material Variances
Variances
Question
Question 11

Zippy

The
The actual
actual price
price per
per pound
pound paid
paid for
for
the
the material
material was
was
a.
a.
b.
b.
c.
c.
d.
d.

$4.00
$4.00 per
per pound.
pound.
$4.10
$4.10 per
per pound.
pound.
$3.90
$3.90 per
per pound.
pound.
$6.63
$6.63 per
per pound.
pound.

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AP = $6,630 1,700 lbs.


AP = $3.90 per lb.

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Material
Material Variances
Variances
Question
Question 22

Zippy

Hansons
Hansons material
material price
price variance
variance (MPV)
(MPV)
for
for the
the week
week was
was
a.
a.
b.
b.
c.
c.
d.
d.

$170
$170 unfavorable.
unfavorable.
$170
$170 favorable.
favorable.
$800
$800 unfavorable.
unfavorable.
$800
$800 favorable.
favorable.

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Material
Material Variances
Variances
Question
Question 22

Zippy

Hansons
Hansons material
material price
price variance
variance (MPV)
(MPV)
for
for the
the week
week was
was
a.
a.
b.
b.
c.
c.
d.
d.

$170
$170 unfavorable.
unfavorable.
$170
$170 favorable.
favorable.
MPV = AQ(AP - SP)
$800
unfavorable.
$800 unfavorable.
MPV = 1,700 lbs. ($3.90 - 4.00)
$800
$800 favorable.
favorable.MPV = $170 favorable

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Material
Material Variances
Variances
Question
Question 33

Zippy

The
The standard
standard quantity
quantity of
of material
material that
that
should
should have
have been
been used
used to
to produce
produce
1,000
1,000 Zippies
Zippies is
is
a.
a.
b.
b.
c.
c.
d.
d.

1,700
1,700 pounds.
pounds.
1,500
1,500 pounds.
pounds.
2,550
2,550 pounds.
pounds.
2,000
2,000 pounds.
pounds.

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Material
Material Variances
Variances
Question
Question 33

Zippy

The
The standard
standard quantity
quantity of
of material
material that
that
should
should have
have been
been used
used to
to produce
produce
1,000
1,000 Zippies
Zippies is
is
a.
a.
b.
b.
c.
c.
d.
d.

SQ = 1,000 units 1.5 lbs per unit


pounds.SQ = 1,500 lbs

1,700
1,700 pounds.
1,500
1,500 pounds.
pounds.
2,550
2,550 pounds.
pounds.
2,000
2,000 pounds.
pounds.

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Material
Material Variances
Variances
Question
Question 44

Zippy

Hansons
Hansons material
material quantity
quantity variance
variance (MQV)
(MQV)
for
for the
the week
week was
was
a.
a.
b.
b.
c.
c.
d.
d.

$170
$170 unfavorable.
unfavorable.
$170
$170 favorable.
favorable.
$800
$800 unfavorable.
unfavorable.
$800
$800 favorable.
favorable.

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Material
Material Variances
Variances
Question
Question 44

Zippy

Hansons
Hansons material
material quantity
quantity variance
variance (MQV)
(MQV)
for
for the
the week
week was
was
a.
a.
b.
b.
c.
c.
d.
d.

MQV = SP(AQ - SQ)


MQV = $4.00(1,700 lbs - 1,500 lbs)
$170
unfavorable.
$170 unfavorable.
MQV = $800 unfavorable

$170
$170 favorable.
favorable.
$800
$800 unfavorable.
unfavorable.
$800
$800 favorable.
favorable.

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Material
Material Variances
Variances
Summary
Summary

Zippy

Actual Quantity

Actual Price

Actual Quantity

Standard Price

Standard Quantity

Standard Price

1,700 lbs.

$3.90 per lb.

1,700 lbs.

$4.00 per lb.

1,500 lbs.

$4.00 per lb.

$ 6,800

$6,000

$6,630

Price variance
$170 favorable
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Quantity variance
$800 unfavorable

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Labor
Labor Rate
Rate and
and Efficiency
Efficiency
Variances
Variances

Lets turn
our
attention
to labor
variances.
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Labor
Labor Rate
Rate and
and Efficiency
Efficiency
Variances
Variances
Actual Hours

Actual Rate

Actual Hours

Standard Rate

Rate Variance
Materials
price- SR)
variance
AH(AR
Labor rate variance
AH
= Actual
Hours
Variable
overhead
AR
= Actual
Rate
spending
variance
McGraw-Hill/Irwin

Standard Hours

Standard Rate

Efficiency Variance
Materials
quantity
variance
SR(AH
- SH)
Labor efficiency variance
SRVariable
= Standard
Rate
overhead
SHefficiency
= Standard
Hours
variance

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Standard
Standard Costs
Costs and
and Variance
Variance
Analysis:
Analysis: An
An Illustration
Illustration

Zippy

Hanson
Hanson Inc.
Inc. has
has the
the following
following labor
labor
standard
standard to
to manufacture
manufacture one
one Zippy:
Zippy:
1.5
1.5 standard
standard hours
hours per
per Zippy
Zippy at
at $8.00
$8.00 per
per hour
hour

Payroll
Payroll records
records last
last week
week show
show 1,450
1,450
hours
hours were
were worked
worked at
at aa total
total labor
labor cost
cost
of
of $11,890
$11,890 to
to make
make 1,000
1,000 Zippies
Zippies that
that
were
were completed
completed on
on May
May 15.
15.
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Labor
Labor Variances
Variances
Question
Question 11

Zippy

Hansons
Hansons actual
actual rate
rate (AR)
(AR) for
for labor
labor
for
for the
the week
week was
was
a.
a.
b.
b.
c.
c.
d.
d.

$8.20
$8.20 per
per hour.
hour.
$8.00
$8.00 per
per hour.
hour.
$7.80
$7.80 per
per hour.
hour.
$7.60
$7.60 per
per hour.
hour.

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Labor
Labor Variances
Variances
Question
Question 11

Zippy

Hansons
Hansons actual
actual rate
rate (AR)
(AR) for
for labor
labor
for
for the
the week
week was
was
a.
a.
b.
b.
c.
c.
d.
d.

$8.20
$8.20 per
per hour.
hour.
$8.00
$8.00 per
per hour.
hour.
$7.80
$7.80 per
per hour.
hour.
$7.60
$7.60 per
per hour.
hour.

McGraw-Hill/Irwin

AR = $11,890 1,450 hours


AR = $8.20 per hour

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Labor
Labor Variances
Variances
Question
Question 22

Zippy

Hansons
Hansons labor
labor rate
rate variance
variance (LRV)
(LRV) for
for
the
the week
week was
was
a.
a.
b.
b.
c.
c.
d.
d.

$290
$290 unfavorable.
unfavorable.
$290
$290 favorable.
favorable.
$400
$400 unfavorable.
unfavorable.
$400
$400 favorable.
favorable.

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Labor
Labor Variances
Variances
Question
Question 22

Zippy

Hansons
Hansons labor
labor rate
rate variance
variance (LRV)
(LRV) for
for
the
the week
week was
was
a.
a.
b.
b.
c.
c.
d.
d.

$290
$290 unfavorable.
unfavorable.
$290
LRV = AH(AR - SR)
$290 favorable.
favorable.
LRV = 1,450 hrs($8.20 - $8.00)
$400
unfavorable.
$400 unfavorable.
LRV = $290 unfavorable
$400
$400 favorable.
favorable.

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Labor
Labor Variances
Variances
Question
Question 33

Zippy

The
The standard
standard hours
hours (SH)
(SH) of
of labor
labor that
that
should
should have
have been
been worked
worked to
to produce
produce
1,000
1,000 Zippies
Zippies is
is
a.
a.
b.
b.
c.
c.
d.
d.

1,550
1,550 hours.
hours.
1,500
1,500 hours.
hours.
1,700
1,700 hours.
hours.
1,800
1,800 hours.
hours.

McGraw-Hill/Irwin

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Labor
Labor Variances
Variances
Question
Question 33

Zippy

The
The standard
standard hours
hours (SH)
(SH) of
of labor
labor that
that
should
should have
have been
been worked
worked to
to produce
produce
1,000
1,000 Zippies
Zippies is
is
a.
a.
b.
b.
c.
c.
d.
d.

SH = 1,000 units 1.5 hours per unit


SH = 1,500 hours
hours.

1,550
1,550 hours.
1,500
1,500 hours.
hours.
1,700
1,700 hours.
hours.
1,800
1,800 hours.
hours.

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Labor
Labor Variances
Variances
Question
Question 44

Zippy

Hansons
Hansons labor
labor efficiency
efficiency variance
variance (LEV)
(LEV)
for
for the
the week
week was
was
a.
a.
b.
b.
c.
c.
d.
d.

$290
$290 unfavorable.
unfavorable.
$290
$290 favorable.
favorable.
$400
$400 unfavorable.
unfavorable.
$400
$400 favorable.
favorable.

McGraw-Hill/Irwin

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Labor
Labor Variances
Variances
Question
Question 44

Zippy

Hansons
Hansons labor
labor efficiency
efficiency variance
variance (LEV)
(LEV)
for
for the
the week
week was
was
a.
a.
b.
b.
c.
c.
d.
d.

LEV = SR(AH - SH)


$290
$290 unfavorable.
unfavorable.
LEV = $8.00(1,450 hrs - 1,500 hrs)
LEV = $400 favorable
$290
$290 favorable.
favorable.

$400
$400 unfavorable.
unfavorable.
$400
$400 favorable.
favorable.

McGraw-Hill/Irwin

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Labor
Labor Variances
Variances
Summary
Summary

Zippy

Actual Hours

Actual Rate

Actual Hours

Standard Rate

Standard Hours

Standard Rate

1,450 hours

$8.20 per hour

1,450 hours

$8.00 per hour

1,500 hours

$8.00 per hour

$11,890

$11,600

$12,000

Rate variance
$290 unfavorable
McGraw-Hill/Irwin

Efficiency variance
$400 favorable

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Learning
Learning Objective
Objective

To compute overhead
variances and explain
the meaning of each.

LO4
McGraw-Hill/Irwin

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Manufacturing
Manufacturing Overhead
Overhead Variances
Variances
Recall
Recall that
that overhead
overhead costs
costs are
are applied
applied to
to
products
products and
and services
services using
using aa
predetermined
predetermined overhead
overhead rate
rate (POHR):
(POHR):
Applied Overhead = POHR Standard Activity

POHR

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Estimated total overhead costs


Estimated activity

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Manufacturing
Manufacturing Overhead
Overhead Variances
Variances
Contains fixed
overhead that
remains constant as
activity changes.

Contains variable
overhead that
increases as
activity increases.

Overhead Rate
Function of activity level
chosen to determine rate.
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Manufacturing
Manufacturing Overhead
Overhead
Variances
Variances Example
Example

Zippy

Hanson, Inc. has the following manufacturing


overhead at three different levels of activity:
Machine Hours
Zippies
Variable Overhead
Fixed Overhead
Total Overhead

2,000
1,000

3,000
1,500

4,000
2,000

$ 4,000
9,000
$ 13,000

$ 6,000
9,000
$ 15,000

$ 8,000
9,000
$ 17,000

Hanson applies overhead based on machine hour activity.


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Overhead
Overhead Variances
Variances
Question
Question 11

Zippy

The
The total
total overhead
overhead rate
rate for
for an
an estimated
estimated
activity
activity of
of 3,000
3,000 machine
machine hours
hours (MH)
(MH) is:
is:
a.
a. $5.00
$5.00 per
per machine
machine hour.
hour.
b.
b. $4.00
$4.00 per
per machine
machine hour.
hour.
c.
c. $3.00
$3.00 per
per machine
machine hour.
hour.
d.
d. $2.00
$2.00 per
per machine
machine hour.
hour.
McGraw-Hill/Irwin

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Overhead
Overhead Variances
Variances
Question
Question 11

Zippy

The
The total
total overhead
overhead rate
rate for
for an
an estimated
estimated
activity
activity of
of 3,000
3,000 machine
machine hours
hours (MH)
(MH) is:
is:
$15,000 3,000 machine hours

a.
a. $5.00
$5.00 per
per machine
machine hour.
hour.
b.
b. $4.00
$4.00 per
per machine
machine hour.
hour.
c.
c. $3.00
$3.00 per
per machine
machine hour.
hour.
d.
d. $2.00
$2.00 per
per machine
machine hour.
hour.
McGraw-Hill/Irwin

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Overhead
Overhead Variances
Variances
Question
Question 11

Zippy

The
The total
total overhead
overhead rate
rate for
for an
an estimated
estimated
activity
activity of
of 3,000
3,000 machine
machine hours
hours (MH)
(MH) is:
is:
$15,000 3,000 machine hours
The $5.00hour.
overhead rate contains
a.
a. $5.00
$5.00 per
per machine
machine
hour.
a variable portion:
b.
b. $4.00
$4.00 per
per machine
machine
hour.MH = $2.00 per MH
$6,000 hour.
3,000
and
a fixed portion:
c.
hour.
c. $3.00
$3.00 per
per machine
machine
hour.
$9,000 3,000 MH = $3.00 per MH
d.
d. $2.00
$2.00 per
per machine
machine hour.
hour.

McGraw-Hill/Irwin

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Manufacturing
Manufacturing Overhead
Overhead Variances
Variances
Actual

Budgeted
Overhead at

Applied
Overhead at

Overhead

Actual Activity

Standard Hours

Spending
Variance

McGraw-Hill/Irwin

Volume
Variance

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Manufacturing
Manufacturing Overhead
Overhead Variances
Variances
Actual

Budgeted
Overhead at

Applied
Overhead at

Overhead

Actual Activity
Standard Hours
Shows how economically
overhead services were
Spending
Volume
purchased
and how
efficiently
overhead
Variance
Variance
services were used.
Contains both fixed
and variable costs.
A controllable variance.

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Manufacturing
Manufacturing Overhead
Overhead Variances
Variances
Actual

Budgeted
Overhead at

Applied
Overhead at

Overhead

Actual Activity

Standard Hours

Spending
Caused
by producing at
a levelVariance
other than that
used for computing the
standard overhead rate.

Volume
Variance

Contains only fixed costs.


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Manufacturing
Manufacturing Overhead
Overhead
Variances
Variances Example
Example

Zippy

Hansons
Hansons actual
actual production
production for
for the
the
period
period was
was 1,600
1,600 Zippies
Zippies resulting
resulting in
in 3,200
3,200
standard
standard machine
machine hours.
hours. Actual
Actual total
total
overhead
overhead cost
cost for
for the
the period
period was
was $15,450.
$15,450.
Compute
Compute the
the overhead
overhead spending
spending
and
and volume
volume variances.
variances.

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Manufacturing
Manufacturing Overhead
Overhead
Variances
Variances Example
Example
Actual
Overhead
$15,450

Zippy

Budgeted
Overhead at

Applied
Overhead at

Standard Hours
$9,000 fixed
+
$6,400 variable

Standard Hours
3,200 hrs.

$5.00 per hr.

$2.00 per hr. 3,200 hrs.

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Manufacturing
Manufacturing Overhead
Overhead
Variances
Variances Example
Example
Actual
Overhead
$15,450

$15,450

Budgeted
Overhead at

Applied
Overhead at

Standard Hours
$9,000 fixed
+
$6,400 variable

Standard Hours
3,200 hrs.

$5.00 per hr.

$15,400

Spending variance
$50 unfavorable
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Zippy

$16,000

Volume variance
$600 favorable

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Disposing
Disposing of
of Variances
Variances
Standard Cost Variances
Immaterial Amounts

Material Amounts

Close to
Cost of Goods Sold

Close by
apportioning to:
Work in Process
Finished Goods
Cost of Goods Sold

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Advantages
Advantages of
of Standard
Standard Costs
Costs
Possible reductions
in production costs.

Improved cost control


and performance
evaluation.
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Advantages

Better information
for planning and
decision making.

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Disadvantages
Disadvantages of
of Standard
Standard Costs
Costs
Emphasis on
negative
exceptions may
impact morale.

It may be difficult
to determine
which variances
are significant.

Disadvantages

Emphasis on negative
exceptions may
lead to under-reporting.
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Learning
Learning Objective
Objective

To discuss the causes of


specific cost variances.

LO5
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Responsibility
Responsibility for
for
Material
Material Variances
Variances
I am not responsible for
this unfavorable material
quantity variance.
You purchased cheap
material, so my people
had to use more of it.

McGraw-Hill/Irwin

Production Manager

You used too much material


because of poorly trained
workers and poorly
maintained equipment.
Also, your poor scheduling
sometimes requires me to
rush order material at a
higher price, causing
unfavorable price variances.

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PurchasingAgent

Responsibility
Responsibility for
for Labor
Labor Variances
Variances
I am not responsible for
the unfavorable labor
efficiency variance!
You purchased cheap
material, so it took more
time to process it.

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Production Manager

You used too much


time because of poorly
trained workers and
poor supervision.

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PurchasingAgent

Responsibility
Responsibility for
for Labor
Labor Variances
Variances
Maybe I can attribute the labor
and material variances to personnel
for hiring the wrong people
and training them poorly.

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Production Manager

The McGraw-Hill Companies, Inc.

Responsibility
Responsibility for
for Labor
Labor Variances
Variances
Using highly paid skilled workers to
perform unskilled tasks results in an
unfavorable rate variance.
High skill,
high rate

Low skill,
low rate

Production
Production managers
managers who
who make
make work
work assignments
assignments
are
are generally
generally responsible
responsible for
for rate
rate variances.
variances.
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The McGraw-Hill Companies, Inc.

Responsibility
Responsibility for
for Labor
Labor Variances
Variances
Poorly
trained
workers

Poor
quality
materials

Unfavorable
Efficiency
Variance
Poor
supervision
of workers
McGraw-Hill/Irwin

Poorly
maintained
equipment

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Summary
Summary of
of Variance
Variance Computations
Computations
and
and Manager
Manager Responsibilities
Responsibilities
Variance
Materials
Price variance
Quantity variance
Labor
Rate Variance
Efficiency variance
Overhead
Spending variance

Volume variance

McGraw-Hill/Irwin

Computation

Manager Responsible

AQ (SP AP)
SP (SQ AQ)

Purchasing agent
Production manager

AH (SR AR)
SR (SH AH)

Production manager
Production manager

Budgeted OH at Actual Production


Level Actual OH

Production manager for


the controllable costs.

Actual OH at Standard Rate


Budgeted OH at Actual Production Level

None A result of producing


at a level other than normal.

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JIT
JIT Systems
Systems and
and Variance
Variance Analysis
Analysis
JIT systems may reduce unfavorable variances.
Long-term agreements
with suppliers eliminate
price variances.

Well-trained flexible
work force reduces labor
efficiency variance.

Emphasis on quality
reduces material
quantity variances.
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Ethics,
Ethics, Fraud,
Fraud, and
and
Corporate
Corporate Governance
Governance
For a company using standard costing systems,
the accuracy of the inventory and cost of goods
sold figures reported in the companys financial
statements is dependent on the reliability of the
standard cost numbers.

A companys financial statements can be


materially misstated when standard costs are
not representative of manufacturing costs
incurred.
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End
End of
of Chapter
Chapter 24
24

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