by James Jiambalvo Chapter 9: Standard Costs and Variance Analysis
Slides Prepared by:
Scott Peterson Northern State University Chapter 9: Standard Costs and Variance Analysis Chapter Themes: Learning Objectives: It’s all about standards 1. Explain how standard costs are developed. and benchmarks. 2. Calculate and interpret variances It is important to measure for direct material. actual values against 3. Calculate and interpret variances goals and standards. for direct labor. Responsibility should be 4. Calculate and interpret variances for manufacturing overhead. commensurate with 5. Discuss how the management by controllability. exception approach is applied to investigation of standard cost variances. Standard Costs The term standard cost refers Learning Objectives: to the cost that management 1. Explain how standard costs are believes should be incurred developed. to produce a good or service 2. Calculate and interpret variances for direct material. under anticipated conditions. 3. Calculate and interpret variances The primary benefit of a for direct labor. standard cost system is that 4. Calculate and interpret variances it allows for comparison of for manufacturing overhead. standard versus actual costs. 5. Discuss how the management by Differences are referred to as exception approach is applied to investigation of standard cost standard cost variances and variances. should be investigated if significant. Standard Costs and Budgets At the outset, it is important Related Learning Objectives: to understand the subtle 1. Explain how standard costs are differences in definitions of developed. standard cost and budgeted 2. Calculate and interpret variances for direct material. cost. 3. Calculate and interpret variances for direct labor. Standard cost: the standard 4. Calculate and interpret variances cost of a single unit. for manufacturing overhead. 5. Discuss how the management by exception approach is applied to Budgeted cost: the cost, at investigation of standard cost variances. standard, of the total number of budgeted units. Development of Standard Costs Standard costs are Related Learning Objectives: developed in a variety of 1. Explain how standard costs are ways. They are developed. 1. specified in engineering 2. Calculate and interpret variances plans. for direct material. 3. Calculate and interpret variances for direct labor. 4. Calculate and interpret variances for manufacturing overhead. 5. Discuss how the management by exception approach is applied to investigation of standard cost variances. Development of Standard Costs Standard costs are Related Learning Objectives: developed in a variety of 1. Explain how standard costs are ways. They are developed. 1. specified by formulas or 2. Calculate and interpret variances recipes. for direct material. 2. developed from price lists 3. Calculate and interpret variances for direct labor. provided by suppliers. 4. Calculate and interpret variances for manufacturing overhead. 5. Discuss how the management by exception approach is applied to investigation of standard cost variances. Development of Standard Costs Standard costs are Related Learning Objectives: developed in a variety of 1. Explain how standard costs are ways. They are developed. 1. specified by formulas or 2. Calculate and interpret variances recipes. for direct material. 2. developed from price lists 3. Calculate and interpret variances for direct labor. provided by suppliers. 4. Calculate and interpret variances 3. determined time and motion for manufacturing overhead. studies conducted by 5. Discuss how the management by industrial engineers. exception approach is applied to investigation of standard cost variances. Development of Standard Costs Standard costs are Related Learning Objectives: developed in a variety of 1. Explain how standard costs are ways. They are developed. 1. specified by formulas or 2. Calculate and interpret variances recipes. for direct material. 2. developed from price lists 3. Calculate and interpret variances for direct labor. provided by suppliers. 4. Calculate and interpret variances 3. determined time and motion for manufacturing overhead. studies conducted by 5. Discuss how the management by industrial engineers. exception approach is applied to 4. developed from analyses of investigation of standard cost past data. variances. Ideal Versus Attainable Standards In developing standard costs, Related Learning Objectives: there are two schools of thought. 1. Explain how standard costs are Ideal standards: developed developed. under the assumption that no 2. Calculate and interpret variances obstacles to the production for direct material. process will be encountered. 3. Calculate and interpret variances They are sometimes referred to for direct labor. as perfection standards. 4. Calculate and interpret variances for manufacturing overhead. Attainable Standards: developed 5. Discuss how the management by under the assumption that there exception approach is applied to will be occasional problems in investigation of standard cost the production process such as variances. equipment failure, labor turnover, and materials defects. A General Approach to Variance Analysis An analysis of the difference Related Learning Objectives: between a standard cost and and 1. Explain how standard costs are actual cost is called variance developed. analysis. The process decomposes the difference in 2. Calculate and interpret two components. variances for direct material. 3. Calculate and interpret For direct material: materials variances for direct labor. price and materials quantity variance. 4. Calculate and interpret variances for manufacturing For direct labor: labor rate (price) overhead. and labor efficiency (quantity) variance. 5. Discuss how the management by exception approach is applied to For overhead: overhead volume investigation of standard cost variance and controllable variances. overhead variance. Material Price Variance The material price variance is Related Learning Objectives: expressed as (AP – SP)AQp 1. Explain how standard costs are where: developed. (AP) = actual price per unit of 2. Calculate and interpret material. variances for direct material. (SP) = standard price per unit of 3. Calculate and interpret variances for direct labor. direct material. 4. Calculate and interpret variances (AQp) = actual quantity of for manufacturing overhead. material purchased. 5. Discuss how the management by If actual price > standard price, exception approach is applied to then the variance is unfavorable. investigation of standard cost If actual price < standard price, variances. then the variance is favorable. Material Quantity Variance The material quantity variance is Related Learning Objectives: expressed as (AQu – SQ)SP 1. Explain how standard costs are where: developed. (AQu) = actual quantity of 2. Calculate and interpret material used. variances for direct material. (SQ) = standard quantity of 3. Calculate and interpret variances material allowed. for direct labor. (SP) = standard price of 4. Calculate and interpret variances material. for manufacturing overhead. If actual quantity > standard 5. Discuss how the management by quantity, then the variance is exception approach is applied to unfavorable. investigation of standard cost If actual quantity < standard variances. quantity, then the variance is favorable. Labor Rate Variance The labor rate (price) variance is Related Learning Objectives: expressed as (AR – SR)AH 1. Explain how standard costs are where: developed. (AR) = actual wage rate (price). 2. Calculate and interpret variances (SR) = standard wage rate for direct material. (price). 3. Calculate and interpret variances for direct labor. (AH) = actual number(quantity) of 4. Calculate and interpret variances labor hours. for manufacturing overhead. If actual rate > standard rate, 5. Discuss how the management by then the variance is unfavorable. exception approach is applied to If actual rate < standard rate, investigation of standard cost then the variance is favorable. variances. Labor Efficiency Variance The labor efficiency (quantity) Related Learning Objectives: variance is expressed as (AH – 1. Explain how standard costs are SH)SR where: developed. (AH) = actual number of hours 2. Calculate and interpret variances worked. for direct material. (SH) = standard number of 3. Calculate and interpret variances for direct labor. hours worked. 4. Calculate and interpret variances (SR) = standard labor wage rate. for manufacturing overhead. If actual hours > standard hours, 5. Discuss how the management by then the variance is unfavorable. exception approach is applied to If actual hours < standard hours, investigation of standard cost then the variance is favorable. variances. Controllable Overhead Variance The controllable overhead Related Learning Objectives: variance is expressed as (actual 1. Explain how standard costs are overhead - flexible budget level developed. of overhead) for actual level of 2. Calculate and interpret variances production. It is referred to as for direct material. controllable because managers 3. Calculate and interpret variances are expected to control costs so for direct labor. they are not substantially 4. Calculate and interpret different from budget. variances for manufacturing If actual > budget, then the overhead. variance is unfavorable. 5. Discuss how the management by exception approach is applied to If actual < budget, then the investigation of standard cost variance is favorable. variances. Overhead Volume Variance The overhead volume variance is Related Learning Objectives: expressed as (flexible budget 1. Explain how standard costs are level of overhead for actual level developed. of production - overhead applied 2. Calculate and interpret variances to production using standard for direct material. overhead rate). This variance is 3. Calculate and interpret variances solely the product of more or for direct labor. less units being produced than 4. Calculate and interpret planned in the static budget. Its variances for manufacturing usefulness is limited. overhead. 5. Discuss how the management by exception approach is applied to investigation of standard cost variances. Investigation of Standard Cost Variances It is important to note that Related Learning Objectives: standard cost variances are not 1. Explain how standard costs are a definitive sign of good or bad developed. performance. These variances 2. Calculate and interpret are merely indicators of potential variances for direct material. problems which must be 3. Calculate and interpret investigated. And there are many variances for direct labor. plausible explanations for them. 4. Calculate and interpret variances for manufacturing overhead. 5. Discuss how the management by exception approach is applied to investigation of standard cost variances. Management by Exception Because investigation of Related Learning Objectives: standard cost variances is itself 1. Explain how standard costs are a costly activity, management developed. must decide which variances to 2. Calculate and interpret variances investigate. Most managers for direct material. practice management by 3. Calculate and interpret variances exception. What is for direct labor. “exceptional?” Usually an 4. Calculate and interpret variances absolute dollar amount or a for manufacturing overhead. percentage dollar amount. 5. Discuss how the management by exception approach is applied to investigation of standard cost variances. “Favorable” Variances May Be Unfavorable The fact that a variance is Related Learning Objectives: “favorable” does not mean that it 1. Explain how standard costs are should not be investigated. Raw developed. materials are good examples of 2. Calculate and interpret variances this phenomenon, especially for direct material. considering the competitive 3. Calculate and interpret variances pricing environment for most for direct labor. commodities. Suppose inferior, 4. Calculate and interpret variances low-priced materials are ordered. for manufacturing overhead. One the one hand, a favorable 5. Discuss how the management by price variance will arise. On the exception approach is applied to other hand, most likely there will investigation of standard cost be substantially more scrap and variances. rework, and thus a higher quantity variance. Responsibility Accounting and Variances As noted previously, Related Learning Objectives: managers should be held 1. Explain how standard costs are responsible only for costs developed. they can control. This is true 2. Calculate and interpret variances for direct material. in the area of variance 3. Calculate and interpret analysis. For example, a variances for direct labor. purchasing agent may be 4. Calculate and interpret held responsible for direct variances for manufacturing material price variances, but overhead. certainly not direct material 5. Discuss how the management by exception approach is quantity (usage) variances. applied to investigation of standard cost variances. Appendix A: Recording Standard Costs in Accounts In a standard costing system, Related Learning Objectives: the costs added to the Raw 1. Record standard costs in the Materials Inventory, Work in account of a manufacturing firm. Process Inventory, Finished Goods Inventory, and Cost of Goods Sold accounts are all recorded at standard rather than actual cost. Variances are also calculated and recorded for management’s use in performance evaluation. Recording Material Costs Purchase of raw materials inventory: Related Account dr. cr. Learning Raw Material Inventory (std.) x Objectives: Material Price Variance x Record standard costs in the Accounts Payable (actual) x account of a (This is an unfavorable price variance) manufacturing firm. Usage of raw materials inventory: Account dr. cr. Work in Process Inventory x Material Quantity Variance x Raw Material Inventory x (This is an unfavorable quantity variance) Recording Labor Cost Account dr. cr. Related Work in Process Inventory (std.) x Learning Labor Rate Variance x Objectives: Labor Efficiency Variance x Record standard costs in the Salaries Payable (actual) x account of a (Note: both the labor rate variance and manufacturing firm. efficiency variance are unfavorable) Recording Manufacturing Overhead Recording manufacturing overhead in a Related standard costing system is a three-step Learning process: Objectives: Record standard 1. Actual overhead is recorded in the costs in the manufacturing overhead account. account of a manufacturing firm. 2. Overhead is applied to Work in Process Inventory at the standard cost. 3. The difference between actual overhead and overhead applied at standard is closed and overhead variances are identified. More Recording Manufacturing Overhead (Step 1) To record actual overhead cost: Related Learning Account dr. cr. Objectives: Manufacturing Overhead x Record standard costs in the *Various Accounts x account of a manufacturing firm.
*Various accounts include indirect wages
payable, utilities payable and accumulated depreciation. Recording Manufacturing Overhead (Step 2) To apply overhead cost to work in process Related inventory at cost: Learning Objectives: Account dr. cr. Record standard Work in Process Inventory x costs in the account of a Manufacturing Overhead x manufacturing firm. Recording Manufacturing Overhead (Step 3) To close out manufacturing overhead cost to Related work in process inventory at cost: Learning Objectives: Account dr. cr. Record standard Manufacturing Overhead x costs in the account of a Overhead Volume manufacturing firm. Variance x Controllable Overhead Variance x Recording Finished Goods To record completed units sent to finished Related goods: Learning Objectives: Account dr. cr. Record standard Finished Goods Inventory x costs in the account of a Work in Process manufacturing firm. Inventory x Recording Cost of Goods Sold To apply overhead cost to work in process Related inventory at cost: Learning Objectives: Account dr. cr. Record standard Cost of Goods Sold x costs in the account of a Finished Goods manufacturing firm. Inventory x Closing Variance Accounts At the end of the accounting period, the Related temporary variance accounts must be closed. Learning As a practical matter this is usually Objectives: accomplished by debiting or crediting the Record standard variances to cost of goods sold. costs in the Account dr. cr. account of a Cost of Goods Sold x manufacturing firm.