Chapter 11: Standard Costs and Variance Analysis Flashcards
Static budget
Budget developed from a single planned level of activity
Flexible budget
A budget developed by using a volume level equal to that actually observed
There are three things to watch for when using budgets for performance
1) The data (the activities being monitored and the standards used to evaluate performance) upon which a budget is based must be appropriate and accurate
2) Actual results must be compared to the proper benchmark
3) To evaluate performance, a variance is computed and interpreted
Variance analysis
Computation, interpretation, and formulation of appropriate follow-up action
Three aspects of performance measurement and evaluation using budgets:
1) Standard setting
2) Preparing flexible budgets and static budgets
3) Computing and interpreting variances
Standard
A benchmark for measuring performance
Quantity standards (SQI)
Specify how much of a resource should be used to make one unit of a product or provide one instance of a service
Example: One pizza have 10 slices of pepperoni (50g)
Price standards (SP)
Specify the price that is expected to be paid for a unit of a resource
Standard cost definition
Standard quantity of input required to produce one unit of product or provide one unit of service to a customer multiplied by the standard price of the input.
Standard cost equation
SQI x SP
There are two different cost objects
1) The standard cost of an input to make one unit of a product
2) The standard cost of making one unit of product or providing one instance of a service
Standard cost card
A detailed listing of the standard amounts of direct materials, direct labour, and variable overhead that should go into a unit of product, multiplied by the standard price or rate that has been set for each cost element.
List of every input required to make one unit of output, along with the corresponding quantity standard, standard price, and standard cost
Ideal standards
Standards that allow for no machine breakdowns or other work interruptions and that require peak efficiency at all times by the most skilled workers.
Unrealistic but in a ‘perfect world example’
Rare and not sustainable
Act as the ultimate stretch targets
Practical standards
Standards that allow for normal machine downtime and other work interruptions and can be attained through reasonable, though highly efficient, efforts by the average worker.
These are tight but attainable
There are 3 issues with ideal standards and stretch targets in general
1) Manager must make a conscious effort to ensure that employees are not discouraged by standards/targets that might ruin the morale within the organization
2) Deviations from ideal standards may be hard to interpret and these must therefore be used with caution and not acted upon hastily
3) Ideal standards cannot be used in forecasting and planning, they do not allow for normal inefficiencies, and therefore they result in unrealistic planning and forecasting figures
Standard price per unit (SP)
The price that should be paid for a single unit of materials, including allowances for quality, quantity purchased, shipping, receiving, and other such costs, net of any discounts allowed.
Standard quantity per unit (SQI)
The amount of materials that should be required to complete a single unit of product, including allowances for normal waste, spoilage, rejects, and similar inefficiencies.
Waste and spoilage
The materials that are wasted as a normal part of the production process or that spoil before they are used
Rejects
Refer to the direct material contained in units that are defective and must be scraped
Direct labour price and quantity standards are usually expressed in terms of:
1) A labour rate
2) labour hours
Standard rate per hour (SP)
The labour rate that should be incurred per hour of labour time, including employment taxes, fringe benefits, and other such labour costs.
Standard hours per unit
The amount of labour time that should be required to complete a single unit of product, including allowances for breaks, machine downtime, cleanup, rejects, and other normal inefficiencies.
Most difficult standard to determine
Variable manufacturing overhead
Generally expressed in terms of rate and the quantity of the base (usually direct labour-hours or machine-hours)
SQI for direct labour x planed Q
Standard cost per unit
The standard cost of a unit of product as shown on the standard cost card; it is computed by multiplying the standard quantity or hours by the standard price or rate for each cost element.
Fixed manufacturing overhead cost
Should not be driven by the volume of output, and a cost per unit has no economic meaning in the sense that a unit of product “causes” a certain cost to be incurred
They can divide the fixed cost to a per unit basis, see slide 26
Unitization of fixed overhead cost
Dividing the fixed costs into per-unit basis to account for FC
Static budget
A budget designed for only one level of activity.
Prepared before the start of the operating year (end)
Calculating the Budgeted Variable Manufacturing Costs, Two Alternative Cost Formulas
1) Standard Cost Times Output Level Approach (C=SCxQ)
2) Standard Price Times Standard Quantity Approach (C=SPxSQ)
1) Standard Cost Times Output Level Approach (C=SCxQ)
The budgeted variable production cost of each input is prepared using the standard cost of the input from the standard cost card
Budgeted cost will be driven by the level of output, Q
2) Standard Price Times Standard Quantity Approach (C=SPxSQ)
The cost driver is the total quantity of an input required to make a given volume of output
This total quantity of an input-labeled as “SQ” must be calculated using the information on the standard of input (SQI) on the standard cost card
Variance
The difference between an actual financial result and the corresponding budgeted amount is called variance
Actual - budgeted = the difference (variance)
Can be favourbale or unfavourbale
Static budget variances
The differences between the actual results and the amounts budgeted in the static budget.
(f)
Favourable
(U)
Unfavorable
To determine if favorable or unfavorable:
First determine if the variance is a revenue variance or a cost variance
If the variance concerns revenue, margin, or income than a positive difference is a favorable variance (actual income is higher than the budgeted income)
If the variance concerns expenditures, a positive difference is an unfavorable variance (actual expenditures are exceeded the budgeted amount)
Negative revenue, margin, or income variances are unfavorable (actual profits is less than budgeted)
Negative cost variances are favourable (actual expenditure is less than the budgeted amount)
The _____ budget is not an ideal basis for performance evaluation
Static
Flexible budget
A budget that is designed to cover a range of activity and that can be used to develop budgeted costs at any point within that range to compare with actual costs incurred.
Any budget based on an activity level different from the planned activity level, and is prepared using the same budget data and standard cost card information as the static budget
Flexing a budget
Only the volume of activity is changed or flexed, and a different budget is prepared
If the planned activity level is the same as the actual activity level there is no need to flex the budget
- Total variable costs change in direct proportion to changes in activity.
- Total fixed costs remain unchangedwithin the relevant range.
What is the difference between the flexible and status budget?
Based on different activity level
Sales volume variances
Differences between the amounts budgeted in the flexible budget and the static budget, arising out of variations in activity level, not cost control.
Flexible budget variances
Differences between the amounts budgeted in the flexible budget and the actual results.
The variances are calculated and evaluated as either favourbale or unfavourbale in the exact same way as the static budget performance report
To understand the source of the flexible budget cost variance we must consider two differences
1) Between the price paid for an input (AP) and the price specified by the standard cost card (SP)
2) Between the quantity of input used (AQ) and the quantity of input allowed for the activity level in the flexible budget (SQ)
The price difference gives rise to a ____ variance
The quantity difference gives rise to a ____ variance
Price
Quantity
Variance analysis
The process of computing and interpreting variances.
Flexible budget variance analysis
The task of computing the price variance and the quantity variance for each type of manufacturing cost and properly interpreting the results.
Materials price variance
A measure of the difference between the actual unit price paid for an item and the standard price, multiplied by the quantity purchased.
Standard quantity of an input allowed for the actual quantity of output
The amount of materials that should have been used to complete the period’s output as computed by multiplying the actual number of units produced by the standard quantity per unit.
The proper benchmark against what to compare the actual usage of an input
Materials quantity variance
A measure of the difference between the actual quantity of materials used in production and the standard quantity allowed, multiplied by the standard price per unit of materials.
(AQ-SQ) x SP
Three control issues
1) Timing of the isolation of variances
2) Responsibility for the variances
3) Eliminating variances in the future
1) Timing of the isolation of variances
“the sooner the better”
The sooner MGMT knows the sooner problems can be evaluated and corrected
Bill of materials
A listing of the quantity of each type of material required to manufacture a unit of product
ALWAYS USE __________ FOR STANDARD COST AND VARIANCE ANALYSIS
PRACTICAL STANDARD (exam answer)
work in process in job-order costing should have a separate work-in-process account for each job (job#90, 92, 93 etc)
work in process in job-order costing should have a separate work-in-process account for each job (job#90, 92, 93 etc) (Exam answer)
Effective managers will want to observe ______, measure _______, and evaluate _________
Appropriately
Accurately
Fairly
Do not mistake SQ for SQI
Recall that the quantity standard specifies the amount of input to make one unit of output, this is SQI
The standard cost card will not show SQ, the total quantity of an input, because SQ will vary with the level of production planned
Why a static budget is not an ideal basis for performance analysis
It is unable to distinguish control over activity from control over costs
It is impossible to properly focus on cost control when an activity level change has occurred at the same time
For example, if you planned to sell 1800 watches and 2000 were sold, a change in the budget had occurred and now we need to adjust for this change to properly evaluate the months results from a cost control perspective
Quantity difference between AQ and SQ is the quantity variance
Remember that the quantity difference by itself is not the variance, however, the variance is obtained by multiplying the quantity difference (AQ-SQ) by the standard price (SP)
2) Responsibility for the variances
The materials price variance should be the responsibility of the individual who has the decision rights over the price - the person who approves a price to e paid to suppliers
Variable overhead spending variance (rate variance)
The difference between the actual variable overhead cost incurred during a period and the standard cost that should have been incurred based on the actual activity of the period.
difference between the actual variable overhead cost and the cost from applying the standard rate to the actual quantity of the allocation base consumed during the production
Variable overhead rate variance =
(AR-SR) x AH
Variable predicted to be $3, turned out to be $2.85, 3-2.85 = 0.15
0.15/hour x 5400/hours = 810F
Alternative for variable overhead
Actual cost - SR x AH
$15,390-$3/hour x 5,400hours
=810F
The concept of efficient in managing variable overhead is directly related to
whether the resources being used as the cost driver has been used efficiently
Variable overhead efficiency variance
The difference between the actual activity (direct labour-hours, machine-hours, or some other base) of a period and the standard activity allowed, multiplied by the variable part of the predetermined overhead rate.
Variable efficiency variance =
AQ-SQxSR
(5400 hours-5000 hours)x$3 hour
Variable overhead efficiency variance =
AQxSR-SQxSR
5400 hours x $3/hour - 5000 hours x $3/hour
Fixed costs of manufacturing include
Facility costs such as property taxes, insurance, heating and power costs, costs for supplies that are periodically purchased in lump-sum quantities, salaries of factory managers and production personnel, lease costs of machinery and equipment and so on
At the beginning of the planning/budgeting cycle, management must
estimate and budget the total amount of costs that the company is expecting to incur
The budgeted amount will stay fixed over the range of values for the main activity level driver
Predetermined fixed overhead application rate =
Budgeted fixed manufacturing overhead cost / Estimated activity level of the allocation base
Three distinct amounts pertaining to fixed manufacturing cost:
1) Actual fixed overhead cost
2) Budgeted fixed overhead cost
3) Allocated (applied) fixed overhead cost
Fixed overhead budget variance
Difference between the budgeted fixed overhead cost and the actual cost.
When the actual cost is different from th enumerator of the rate (the budgeted fixed overhead cost), the difference is this
Denominator activity level (practical capacity of the facility)
The activity level used to compute the predetermined overhead allocation rate.
The estimated activity level of the allocation base for the operating period
Fixed overhead volume variance (production volume variance)
Difference between the budgeted cost and the allocated cost; also called the production volume variance.
Volume variance
The variance that arises when actual output during a period is different from the planned output. It is a measure of how well the organization’s facilities are utilized.
Reliant on activity control and not cost control
Cost control over fixed manufacturing overhead as two parts
1) Concerns whether actual spending for fixed overhead cost compares favourably with the amount budgeted in the static as well as the flexible budget
2) Concern the implications of a volume difference between the quantity of the allocation base to which the predetermined overhead rate is applied to allocate the fixed overhead and the denominator activity level of the allocation base
Budget variance
Difference between the actual fixed overhead cost and the amount budgeted in the flexible budget
A measure of the difference between the actual fixed overhead costs incurred during the period and budgeted fixed overhead costs as contained in the flexible budget.
Actual fixed overhead cost - Budgeted fixed overhead cost
Normal costing system
One where the overhead allocation is based on a predetermined overhead application rate, and the rate is applied to the actual quantity of the allocation base consumed during a period
Standard costing system
Overhead allocation is based on a predetermined overhead application rate, and the rate is applied to the standard quantity of the allocation base allowed for the actual quantity of output produced in a period
If the normal and actual production levels are the same, then the denominator activity level and standard hours allowed for the output of the period are the same,
and there is no volume variance
If the actual production is less than normal production, the the denominator activity level is greater than the standard hours allowed for the output of the period, and the volume variance is _______
unfavourable
Less = bad
If the actual production is greater than normal production, the the denominator activity level is less than the standard hours allowed for the output of the period, and the volume variance is _______
favourable
More = good
aka Standard more than denominator
If a variance is ___% or more it is significant
5
Management by exception
A system of management in which standards are set for various operating activities, with actual results then compared with these standards. Any differences that are deemed significant are brought to the attention of management as exceptions.
Advantages of standard costs
Page 545, fuck this cunt of a textbook
Potential problems with standard costs
Page 545, fuck this cunt of a textbook
The managers in charge of production would generally be responsible for controlling the _______________ variance.
Labour efficiency
Which of the following variances is caused by a difference between the denominator activity in the predetermined overhead rate and the standard hours allowed for the actual production of the period?
fixed overhead volume variance.
A company’s static budget estimate of total overhead costs was $200,000 based on the assumption that 20,000 units would be produced and sold. The company estimates that 30% of its overhead is variable and the remainder is fixed. What would be the total overhead cost according to the flexible budget if 24,000 units were produced and sold?
First, determine the budgeted variable overhead as follows:
$200,000 budgeted overhead cost x 30% (variable portion) = $60,000
Next, determine the budgeted variable overhead per unit as follows:
$60,000 ÷ 20,000 units = $3.00 per unit
Then, determine the budgeted fixed overhead as follows:
$200,000 budgeted overhead cost x 70% (fixed portion) = $140,000
Finally, the flexible budget at 24,000 units is determined as follows:
(24,000 units x $3.00 per unit variable overhead) + $140,000 fixed overhead = $212,000
Baxter Company uses a standard cost system in which manufacturing overhead is applied to units of product on the basis of direct labour-hours. The variable portion of the company’s predetermined overhead rate is $3 per direct labour-hour. The standards call for 2 direct labour-hours per unit of output. In March, the company produced 2,000 units using 4,100 direct labour-hours and the actual variable overhead cost incurred was $12,050. What was the variable overhead spending variance?
Spending var. = (AH x AR) − (AH x SR)
= ($12,050) − (4,100 x $3)
= $250 F
Standard Costing
**General Approach ***
- Determine the Standard Quantity per Unit
- Determine the Standard Price (or Rate) per Unit
- Determine the Standard Cost per Unit
Standard Quantity per Unit x Standard Price (or Rate) per Unit = Standard Cost per Unit
Determining Standard Costsiii) Variable Manufacturing Overhead
- .Determine the Standard Quantity (of allocation base) per Unit
- Determine the Standard Rate per Unit
- Determine the Standard Cost per Unit
Standard Quantity (Hours) per Unit x Standard Rate per Unit = Standard Cost per Unit
Determining Standard Costsiv) Total
i) Standard cost of material (per unit)+ii) Standard labour cost (per unit) + iii) Standard variable manufacturing overhead cost (per unit)=iv) Total standard cost (per unit)
There are two primary reasons for unfavourable variable overhead variances:
- Spending too much for resources.
2. Using the resources inefficiently.
Material Price Variance:
should be the responsibility of the individual who has the decision rights over the price (i.e. purchasing manager).
Quantity Variances:
it is generally the responsibility of the production department to see that materials usage is kept in line with standards.
Labour Variances
Price variance for direct labour is commonly termed labour rate variance.The quantity variance for direct labour is called the labour efficiency variance
Labour rate variance: LRV=(AR-SR)xAH
Labour efficiency variance:
LEV=(AH-SH)xSR
The manager in charge of production would generally be responsible for controlling the____________
labour efficiency variance
Advantages of Standard Costs
Possible reductionsin production costs
Management byexception
Better Informationfor planning anddecision making
Improved cost controland performanceevaluation
Appendix 11A: General Ledger Entries to Record Variances
-Standard costs and variances do not formally need to be in accounting records
General Ledger Entries to Record Variances
Inventories and cost of goods sold can be valued at their standard costs which eliminates the need to keep track of the actual cost of each unit.
The difference between actual and standard costs are entered into special accounts that accumulate the various standard cost variances.
Closing entries are made at the end of the accounting period to adjust the financial statements to reflect the actual costs.
To isolate the variance, note the following:
1) Liabilities (purchases and expense) are recorded at the actual values; entries to accounts payable are recorded as AQxAP
2) Inventoriable assets like raw materials added to or removed from inventory are recorded as AQxSP
3) Resources (materials, labour, overhead) are applied to production (work in process) at standard quantities allowed for the actual production volume valued at standard prices: SQxSP
4) Finished goods are transferred from work in process to finished goods inventory at the full standard cost, including applied fixed overhead: QxSC
5) Cost of goods sold is also recorded at standard cost, including applied overhead: QxSC
Direct materials (accounts) purchase of materials Example: XYZ company purchased 18kg of material from supplier at a price of $600 per KG for a total cost of $10,800:
Raw Materials (18kg for 500/kg) 9000 Materials price variance (18kgx100/kg,U) 1800 Accounts payable (for buying 18kg at 600/kg) 10800
Quantity Variance (accounts)
Work in process (materials: 10kg at $500/kg) 5000 Materials quantity variance([11kg-10kg]x500) 500 Raw Materials(11kg at 500/kg) 5500
Direct labour variance (accounts)
Work in process (labour:SHxSR=3000 @ $20) 60,000 Direct labour hour flexible budget variance 18,000 Wages Payable(AHxAR=400hrs @ 19.50/hr) 78000
Variable manufacturing overhead variances (indirect labour)
In June XYZ paid 10,000 for maintenance and utilities, and 10,800 for indirect labour
Variable manufacturing overhead 20,800
Accounts payable 10,000
Wages payable 10,800
Variable manufacturing overhead variances (direct labour)
Work in process 15,000
Variable manufacturing overhead 15,000
To record the flexible budget variance and close the variable manufacturing overhead account
Flexible budget variance (MOH) 5,800
Variable manufacturing overhead 5,800
Fixed manufacturing overhead variance
To record the incurrence of manufacturing overhead cost
Fixed manufacturing overhead 11,750
Accounts payable 10,000
Prepaid insurance, factory 750
Property taxes payable 1,000
To isolate the flexible budget variance (accounts)
TO clear FMOH control and isolate the flexible budget variance
Fixed manufacturing overhead control 250
Flexible budget variance 250
Entries to close the variance accounts
XYZ company closes the variances to the cost of goods sold (COGS)
FAVOURBALE
Variance account XXXX
Cost of goods sold XXXX
Entries to close the variance accounts
XYZ company closes the variances to the cost of goods sold (COGS)
UNFAVOURBALE
Cost of goods sold XXXX
Variance account XXXX
The entry to close out the materials price variance
To close the materials price variance account to cost of goods sold
Cost of goods sold 1,800
Materials price variance 1,800
The entry to close out the labour rate variance
Labour rate variance 2,000
Cost of goods sold 2,000
