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Chapter 10

Standard Costs
and
Variance Analysis

Originally prepared by Shannon Butler, CPA, CA, University of Western Ontario.


Substantially revised by the Com 316 instructors, Gustavson School of Business,
University of Victoria.
Standard Costs
Standards are benchmarks or norms
used for measuring performance.

Two types of standards are commonly used:

Quantity standards Price standards


specify how much of an specify how much
input should be used to should be paid
make a product or for each unit
provide a service. of the input.

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Price and Quantity
Standards
Price and quantity standards are
determined separately for two reasons:

TheThe purchasing
purchasing manager
manager is is responsible
responsible for
for the
the price
price of
of
the
the raw
raw material
material purchased
purchased andand thethe production
production manager
manager
is
is responsible
responsible for
for the
the quantity
quantity of
of raw
raw material
material used.
used.

The
The buying
buying and
and using
using activities
activities occur
occur at
at different
different times,
times,
so
so the
the price
price and
and quantity
quantity variances
variances areare also
also calculated
calculated at
at
different
different times.
times.
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Types of Standard
Costs
Ideal standards: Can only be attained under the best
circumstances. Everything has to be done at 100% efficiency to
achieve these standards.
Seldom used, because the variances are always unfavourable and
therefore less useful demotivating and often dismissed as being
inevitable.

Practical standards: Tight but attainable. Things have to be done


with reasonable efficiency to achieve these standards.
Most commonly used, because they allow for unavoidable waste and
normal inefficiencies, making the resulting variances more
meaningful.
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Standard Cost
Variance Analysis

Differences or variances
between the actual costs and the
standard costs are calculated,
and any that are significant
are reported to management.

Allows targeted questions to be asked

and appropriate actions to be taken.5


Standard Cost Card
for Variable Production
Costs
A standard cost card for one unit
of product might look like this:

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General Model for
Variance Analysis
Variance Analysis

Price Variance Quantity Variance

Due to difference between Due to difference between


actual price and actual quantity and
standard price standard quantity

Materials price variance Materials quantity variance


Labour rate variance Labour efficiency variance
VOH spending variance VOH efficiency variance 7
General Model for
Variance Analysis

Actual Quantity Actual Quantity Standard Quantity



Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Flexible Budget Variance


These terms should be self-explanatory, other than the Standard Quantity.
General Model for
Variance Analysis
This is the standard quantity allowed for the actual output.

Actual Quantity Actual Quantity Standard Quantity



Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Flexible Budget Variance

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General Model for
Variance Analysis

Actual Quantity Actual Quantity Standard Quantity



Actual Price Standard Price Standard Price

Price Variance Quantity Variance

(AQ AP) (AQ SP) (AQ SP) (SQ SP)

or AQ x (AP SP) or (AQ SQ) x SP

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Materials Variances
Example 1
Glacier Outfitters has the following standards for the
direct material, fibrefill, used to produce its mountain
parkas:
0.2 kg of fibrefill per parka, at $5.00 per kg.

Last month, 420 kgs of fibrefill were purchased for


$4.90 per kg.

All of this material was used to make 2,000 parkas.

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Materials Variances

Actual Quantity Actual Quantity Standard Quantity



Actual Price Standard Price Standard Price
____ kgs. ____ kgs. ____ kgs.

$____ per kg. $____ per kg. $____ per kg.
= $______ = $______ = $______

Price variance Quantity variance


$________________ $________________

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Responsibility
for Materials Variances
The Production Manager is usually responsible for the Materials
Quantity Variance.
However, if the purchasing department buys cheap material and more of
it has to be used in production, then the Purchasing Manager should be
held responsible for the unfavourable quantity variance.

The Purchasing Manager is usually responsible for Materials


Price Variance.
However, if poor scheduling by the production department forces
Purchasing to buy the material at a higher price, then the Production
Manager is responsible for the unfavourable price variance.
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Materials Variances
when purchases and
usage differ
In the previous example, the company purchased
and used 420 kgs of fibrefill.
How are the variances computed if the amount
purchased differs from the amount used?

The price variance is computed on the entire


quantity purchased.

The quantity variance is computed only on the


quantity used. 14
Materials Variances
Example 2
As before, Glacier Outfitters has the following direct
material standard for the fibrefill used to produce its
mountain parkas:

0.2 kg of fibrefill per parka, at $5.00 per kg.

Last month, 500 kgs of fibrefill were purchased for


$4.90 per kg.

420 kgs of fibrefill were used to make 2,000 parkas.

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Materials Variances Example
2
Actual Quantity Actual Quantity
Purchased Purchased

______
Actual kgs.
Price ______Price
Standard kgs.

$____ per kg. $____ per kg.
= $______ = $______

Price variance The price variance is now


$______________ larger because the quantity
purchased was larger.
Materials Variances Example
2
Actual Quantity
Used Standard
Quantity

Standard Price Standard Price
420 kgs. 400 kgs.

$5.00 per kg. $5.00 per
kg.
= $2,100 = $2,000
The quantity variance is
Quantity variance
unchanged, because the
$100 unfavourable
quantity used and the standard
quantity are unchanged. 17
Labour Variances
Example
Glacier Outfitters has the following direct labour standard for its
mountain parkas:

1.2 hours per parka, at $10.00 per hour

Last month, employees worked 2,500 hours at a total labour


cost of $26,250 to make 2,000 parkas.

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Labour Variances
Example
Actual Hours Actual Hours Standard Hours

Actual Rate Standard Rate Standard Rate
______ hours ______ hours ______ hours

$_____ per hour $_____ per hour $_____ per hour
= $_______ = $_______ = $_______

Rate variance
Efficiency variance
$__________________ $__________________

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Responsibility for
Labour Variances
Mix of skill levels
Production assigned to tasks
managers are (which affects the
usually held average cost per hour).
responsible
for labour Level of employee
variances, motivation.
because they can
influence the Quality of production
supervision.

Quality of training
provided to employees.
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Lets practice

Exercises 10-9
and 10-10
Variable Overhead
Variances Example
Glacier Outfitters uses direct labour hours as the basis for
applying manufacturing overhead to its products, and has
the following variable overhead standard for its mountain
parkas:
1.2 direct labour hours per parka, at $4.00 per hour

Last month, employees worked 2,500 hours to make 2,000


parkas, and the variable manufacturing overhead cost for
the month was $10,500.

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Variable Overhead
Variances
Actual Hours Actual Hours Standard Hours

Actual Rate Standard Rate Standard Rate
______ hours ______ hours ______ hours

$_____ per hour $_____ per hour $_____ per hour
= $_______ = $_______ = $_______

Spending variance Efficiency variance


$__________________ $__________________

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Fixed Overhead
Analysis

Recall from chapter 5 that overhead costs are


applied to products and services using a
predetermined overhead rate (POHR).

The POHR can be broken down into


variable and fixed components.

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Overhead Rates and
Fixed Overhead
Analysis
For the fixed manufacturing overhead costs:

Budgeted fixed overhead costs


PFOHR =
Budgeted level of activity

Applied Fixed Overhead =

PFOHR Standard Hours Allowed for the Actual Output

Note that overhead is applied based on the time that should


have been taken (not the actual time) to produce the output.
Fixed Overhead
Variances
Actual Budgeted Applied Fixed
Fixed Fixed
Overhead Overhead Overhead
PFOHR x
Standard Hours
Allowed for
Actual Output

Fixed Overhead Fixed Overhead


Spending or Volume
Budget Variance Variance
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Fixed Overhead
Variances
Spending or Budget Variance
reflects the difference between the actual
fixed overhead costs incurred during the
period and the budgeted fixed overhead costs

Volume Variance
reflects whether the activity level was higher
or lower than what was budgeted
does not represent good or bad cost control

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Fixed Overhead
Variances Example
ColaCo manufactured 1,600 units last month.
The standard machine time to produce each unit is
2 hours, while the actual time was 2.1 hours.
The budgeted activity level was 3,000 machine hours.

The budgeted fixed overhead was $9,000, and the actual fixed overhead was $8,450.

The PFOHR was $_____ per machine hour.

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Fixed Overhead
Variances
Actual Budgeted Applied Fixed
Fixed Fixed
Overhead Overhead Overhead
PFOHR x
Standard Hours
Allowed for
Actual Output

Fixed Overhead Fixed Overhead


Spending or Volume
Budget Variance Variance 29
Volume Variance A Closer
Look

The volume variance reflects whether the


firms productive capacity was used more or
less than expected.

A low level of capacity utilization results in


an unfavourable volume variance.

A high level of capacity utilization results in


a favourable volume variance.

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Overhead Variances and
Under- or Overapplied
Overhead

In a standard cost
Unfavourable system: Favourable
overhead variances overhead variances
are equivalent to are equivalent to
underapplied overhead. overapplied overhead.

The sum of the overhead variances equals


the underapplied or overapplied overhead.
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Lets practice

Exercise 10-13
Exhibit
10-9

Investigating Variances

o Management has to decide whether the reported


variances require further action. Not all variances are
worth investigating.

o Management should consider both the dollar amount


of the variance and its relative size in comparison to the
amount of cost involved.

o Other approaches, such as statistical control charts,


can also be used to decide which variances should be
investigated.

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Advantages of
Standard Costing
Promotes efficiency and control
Facilitates management by exception; only
the significant variances are brought to
managements attention
Facilitates determining who or what is
responsible for the cost variances

Simplifies bookkeeping
Inventories and cost of goods sold are
recorded at their standard costs 34
Potential Problems
with Standard Costing
Too much emphasis on negative aspects (i.e., unfavourable
variances) could impact morale.

There are often complex inter-relationships between


materials, labour and overhead variances.
Responsibility for variances can be difficult to pinpoint.
(e.g, the Production Department might blame the
Purchasing Department, or vice-versa).
If overhead is applied on the basis of direct labour,
labour efficiencies or inefficiencies will affect the
overhead variances as well as the labour variances. 35
Standard Costs and
Variances in the Service
Industry

Although standard costing has its roots in


the manufacturing industry,
it can also help firms in the service industry
plan and control their costs.

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Lets practice

Problem 10-19