CHAPTER

CHAPTER 11
11
Standard Costs
and
Variance Analysis
Slide 11-2

Standard
Standard Costs
Costs and
and Budgets
Budgets
Standard cost
- Cost that management believes should
be incurred to produce a product or
service under anticipated conditions
- Often refers to cost of a single unit

Budgeted cost
- Cost, at standard, of the total number of
budgeted units

Slide 11-3

Learning objective 1: Explain how standard

costs are developed

Standard
Standard Costs
Costs and
and Budgets
Budgets

If materials budget indicates purchases of 5,000

pounds, standard cost is $25,000 (5,000 pounds
x $5 standard cost per pound)
If labor budget is prepared for 1,000 units
produced, 3,000 labor hours are needed at total
cost of $30,000
Slide 11-4

Learning objective 1: Explain how standard

costs are developed

Starbucks
Starbucks

Slide 11-5

Learning objective 1: Explain how standard

costs are developed

Development
Development of
of Standard
Standard Costs
Costs
Standard quantity and price for
material may be specified:
- in engineering plans that provide a list
of material
- in recipes or formulas
- by time and motion studies
- in price lists provided by suppliers

Slide 11-6

Learning objective 1: Explain how standard

costs are developed

Development
Development of
of Standard
Standard Costs
Costs
Standard quantity and rate for direct labor
may be specified:
- by time and motion studies
- through analysis of past data
- by management expectations of rates to be
paid
- in contracts that set labor rates
Standard costs for overhead involves
procedures similar to those used to develop
predetermined overhead rates
Slide 11-7

Learning objective 1: Explain how standard

costs are developed

Development
Development of
of Standard
Standard Costs
Costs
Ideal standards assumes that no
obstacles in production process, i.e.:
- no breakdowns in equipment
- no defects in materials
Emphasizes a perfect production
environment

Slide 11-8

Learning objective 1: Explain how standard

costs are developed

Development
Development of
of Standard
Standard Costs
Costs
Attainable standards takes into
account possible circumstances that
could lead to costs greater than ideal
It allows for:
Downtime
Inefficiencies
Waste

Slide 11-9

Learning objective 1: Explain how standard

costs are developed

Development
Development of
of Standard
Standard Costs
Costs
Ideal standards
- Developed under the assumption that no
obstacles will be encountered
- Ideal standards may not be useful for planning
purposes especially if defects and breakdowns
are a fact of life
Attainable standards
- Take into account possibility of a variety of
circumstances may lead to costs greater than
ideal

Slide 11-10

Learning objective 1: Explain how

standard costs are developed

What is the primary benefit of a standard

costing system?
a. It records costs at what should have been
incurred
b. It allows a comparison of differences
between actual and standard costs
c. It is easy to implement
d. It is inexpensive and easy to use
Answer: b
It allows a comparison of differences between
actual and standard costs
Slide 11-11

Learning objective 1: Explain how standard

costs are developed

Which of the following is not a way to develop a

standard cost?
a. By using a fixed rate that is higher every
period
b. By performing time and motion studies
c. By analyzing past data
d. By using what is specified in engineering
plans

Answer: a
By using a fixed rate that is higher every period
Slide 11-12

Learning objective 1: Explain how standard

costs are developed

Development
Development of
of Standard
Standard Costs
Costs

Slide 11-13

Learning objective 1: Explain how standard

costs are developed

A
A General
General Approach
Approach to
to Variance
Variance
Analysis
Analysis
Standard cost variance
- Difference between a standard and an
actual cost

Variance analysis
- Breaking down the differences between
standard and actual cost into two
components, i.e. price and quantity
variance

Slide 11-14

Learning objective 1: Explain how standard

costs are developed

A
A General
General Approach
Approach to
to Variance
Variance
Analysis
Analysis
Direct material variances
- Material price variance
- Material quantity variance

Direct labor variances

- Labor rate variance
-Labor efficiency variance

Manufacturing overhead variances

- Overhead volume variance
- Controllable overhead variance
Slide 11-15

Learning objective 1: Explain how standard

costs are developed

A
A General
General Approach
Approach to
to Variance
Variance
Analysis
Analysis

Slide 11-16

Learning objective 1: Explain how standard

costs are developed

Material
Material Variances
Variances
Material price variance
- Difference between the actual price per
unit of material and the standard price
per unit of material

Material quantity variance

- Difference between the actual quantity
of material used and the standard
quantity of material allowed for the
number of units produced

Slide 11-17

Learning objective 2: Calculate and interpret

variances for direct material

Material
Material Variances
Variances

Slide 11-18

Learning objective 2: Calculate and

interpret variances for direct material

Material
Material Variances
Variances
Standard for 1 unit: 400 lbs @ $10 per lb
Materials purchased: 200,000 lbs @ $9.90 per lb
Materials used: 181,000 lbs to produce 450 units

Slide 11-19

Learning objective 2: Calculate and

interpret variances for direct material

You
You Get
Get What
What You
You Measure!
Measure!

Slide 11-20

Learning objective 2: Calculate and

interpret variances for direct material

Data for chips used in the production of computers

Standard: 3 chips per computer @ $6.50 per chip
Quantity purchased: 200 chips for total of $1,350
Quantity used: 123 chips for production of 40 units
Calculate the material price variance:

Slide 11-21

Learning objective 2: Calculate and

interpret variances for direct material

Data for chips used in the production of computers

Standard: 3 chips per computer @ $6.50 per chip
Quantity purchased: 200 chips for $1,350 total
Quantity used: 123 chips for production of 40 units
Calculate the material quantity variance:

Slide 11-22

Learning objective 2: Calculate and

interpret variances for direct material

Direct
Direct Labor
Labor Variances
Variances
Labor Rate Variance
- Difference between actual wage rate
and standard wage rate x actual
number of labor hours
Labor Efficiency Variance
- Difference between actual number of
hours work and standard labor hours
allowed for the number of units
produced x standard wage rate

Slide 11-23

Learning objective 3: Calculate and interpret

variances for direct labor

Direct
Direct Labor
Labor Variances
Variances

Slide 11-24

Learning objective 3: Calculate and

interpret variances for direct labor

Direct
Direct Labor
Labor Variances
Variances
Standard for 1 unit: 4 hours @ $15 per hour
Actual labor: 1,700 hours @ $15.50 per hour to
produce 450 units

Slide 11-25

Learning objective 3: Calculate and

interpret variances for direct labor

Data for labor used in the production of sneakers

Standard: .25 hours per sneaker at $12.00 per hour
Actual quantity produced: 24,500 sneakers
Quantity used: 6,000 hours, total cost $69,000
Calculate the labor rate variance:

Slide 11-26

Learning objective 3: Calculate and

interpret variances for direct labor

Data for labor used in the production of sneakers

Standard: .25 hours per sneaker at $12.00 per hour
Actual quantity produced: 24,500 sneakers
Quantity used: 6,000 hours, total cost $69,000
Calculate the labor efficiency variance:

Slide 11-27

Learning objective 3: Calculate and

interpret variances for direct labor

Overhead
Overhead Variances
Variances
Controllable overhead variance
- Difference between actual amount of
overhead and amount of overhead included in
a flexible budget for actual production levels

Overhead volume variance

- Difference between flexible overhead budget
for actual level of production and overhead
applied using the standard overhead rate

Slide 11-28

Learning objective 4: Calculate and interpret variances

for manufacturing overhead

Overhead
Overhead Variances
Variances
Standard for 1 unit: $50 overhead applied
Actual overhead: $23,000 to produce 450 units
Flexible budget overhead: $15,000 fixed + $20
per unit produced

Slide 11-29

Learning objective 3: Calculate and

interpret variances for direct labor

Standard
Standard Cost
Cost Variance
Variance Formulas
Formulas

Slide 11-30

Learning objective 5: Calculate the financial impact of operating at

more or less than planned capacity

Standard
Standard Cost
Cost Variance
Variance Formulas
Formulas

Slide 11-31

Learning objective 5: Calculate the financial impact of operating at

more or less than planned capacity

Interpreting
Interpreting Overhead
Overhead Volume
Volume
Variance
Variance
Volume variance do not signal that overhead
costs are in or out of control
Volume variance signals that more or fewer
units were produced than planned when
standard overhead rate developed:
- Favorable: more units produced than planned
- Unfavorable: fewer units produced than
planned
To measure the financial impact of producing
more or fewer units than planned, use
incremental analysis

Slide 11-32

Learning objective 5: Calculate the financial impact of

operating at more or less than planned capacity

A favorable labor efficiency variance means:

a. Labor rates were higher than called for by
standards
b. Inexperienced labor was used, causing the rate
to be lower than standard
c. More labor was used than called for by
standards
d. Less labor was used than called for by
standards
Answer: d
Less labor was used than called for by standards

Slide 11-33

Learning objective 5: Calculate the financial impact of

operating at more or less than planned capacity

What does an unfavorable overhead volume

variance mean?
a. Overhead costs are out of control
b. Overhead costs are in control
c. Production was greater than anticipated
d. Production was less than anticipated
Answer: d
Production was less than anticipated

Slide 11-34

Learning objective 5: Calculate the financial impact of

operating at more or less than planned capacity

Investigation
Investigation of
of Standard
Standard Cost
Cost
Variances
Variances
Standard cost variances do not provide
definitive evidence
Should be viewed as an indicator of
potential problem areas
Must investigate facts behind the
variances

Slide 11-35

Learning objective 5: Calculate the financial impact of

operating at more or less than planned capacity

Standard
Standard Cost
Cost Variances
Variances

Slide 11-36

Learning objective 5: Calculate the financial impact of

operating at more or less than planned capacity

Management
Management by
by Exception
Exception
Investigation of standard cost
variances is a costly activity
Investigate only those variances that
are considered exceptional
Must determine criteria to measure
what is considered exceptional
- Absolute dollar value
- Percent of actual or standard cost

Slide 11-37

Learning objective 6: Discuss how the management-by-exception approach is

applied to the investigation of standard cost variances

Favorable
Favorable Variances
Variances May
May Be
Be
Unfavorable
Unfavorable
A variance that is favorable should
not be exempt from investigation It
could indicate poor management
decision
A poor decision regarding the quality
of raw materials might result in an
unfavorable variance in material
quantity

Slide 11-38

Learning objective 7: Explain why a favorable variance may be unfavorable, how process
improvements may lead to unfavorable variances, and why evaluation in terms of variances may
lead to overproduction

Can
Can Process
Process Improvements
Improvements Lead
Lead
to
to Unfavorable
Unfavorable Variances?
Variances?
Process improvements can lead to
greater efficiency in production
Greater efficiency results in actual
labor hours being less than standard
labor hours
Firms should stimulate greater
demand to take advantage of the
greater production capabilities

Slide 11-39

Learning objective 7: Explain why a favorable variance may be unfavorable,

how process improvements may lead to unfavorable variances, and why
evaluation in terms of variances may lead to overproduction

Evaluation
Evaluation in
in Terms
Terms of
of Variances
Variances
Can
Can Lead
Lead to
to Excess
Excess Production
Production
When bottlenecks exist, the department
in front of the bottleneck should not
produce more than the bottlenecked
department can handle
If it does it will create excess work-inprocess inventory and result in a
negative impact on shareholder value

Slide 11-40

Learning objective 7: Explain why a favorable variance may be unfavorable,

how process improvements may lead to unfavorable variances, and why
evaluation in terms of variances may lead to overproduction

Responsibility
Responsibility Accounting
Accounting and
and
Variances
Variances
Managers should be held responsible
for only the costs they can control
Additionally, managers and workers
should only be held responsible for
variances they can control

Slide 11-41

Learning objective 7: Explain why a favorable variance may be unfavorable,

how process improvements may lead to unfavorable variances, and why
evaluation in terms of variances may lead to overproduction

Quality
Quality

Slide 11-42

Learning objective 7: Explain why a favorable variance may be unfavorable,

how process improvements may lead to unfavorable variances, and why
evaluation in terms of variances may lead to overproduction

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Slide 11-43