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Managerial Accounting

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:
Its 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 managements
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.

Overhead Volume Variance x


Controllable Overhead Variance x
Material Price Variance x
Material Quantity Variance x
Labor Rate Variance x
Labor Efficiency Variance x
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