Lecture Cost management: Measuring, monitoring, and motivating performance (2e): Chapter 11 - Eldenburg, Wolcott’s

Cost Management

Measuring, Monitoring, and Motivating Performance

Chapter 11
Standard Costs and Variance Analysis

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 1


Chapter 11: Standard Costs & Variance Analysis

Learning objectives
•

•

Q1: How does variance analysis contribute to the strategic
management process?
Q2: What is a standard costing system and how is it used?

•

Q3: How are direct cost variances calculated?

•

Q4: How is direct cost variance information analyzed and used?

•

Q5: How are variable and fixed overhead variances calculated?

•

Q6: How is overhead variance information analyzed and used?

•

Q7: How are manufacturing cost variances closed?

•

Q8: Which profit-related variances are commonly analyzed?

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 2


Q2: Standard Costs
•

•

•

Organizations set standards to help plan
operations.
A standard cost is the expected cost of
providing a good or service.
In manufacturing, the standard cost of a
unit of output is comprised of:

•
•

the standard price (SP) of the input, and
the standard quantity of the input expected
to be consumed in the production of one
output unit.

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 3


Q2: Standard Costs

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 4


Q2: Establishing & Using Standard Costs
•

Standards can be set using:
•
•
•

•

Information from the prior year
Engineered estimates
New information available

Standards can be used for:
•
•
•
•

Planning future operations
Monitoring current operations
Motivating manager and employee behavior
Evaluating performance

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 5


Q2: Standard Costing Systems
Advantages
Information can be
used to quickly
estimate job or project
costs
Monitor resources to
measure efficiency
Communicates
targets (goals) to
employeess
Provides information
to analyze operations
•

•

•

•

•

Disadvantages
May reduce employee
motivation if the
standards are too high
or low
Time involved in setting
standards and
analyzing variances
Incorrect standards
could result in
inappropriate employee
rewards or penalties
ã

ã

ã

ã

â John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 6

Q1: Variance Analysis
•

•

The difference between an actual cost and
the standard cost of producing goods or
services at the actual volume level is
called a standard cost variance.
Managers investigate the reasons for
standard cost variances so that:
•
•
•

efficiencies can be rewarded and replicated,
inefficiencies can be minimized, and
the validity of the standards can be assessed.

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 7


Q1: Variance Analysis in Diagnostic Control System
•

Investigating Variances
–
–
–

•

Must decide what amount of variance needs to be
investigated (% of budget, given $ amount)
Trends in variances should also be considered
Separating variances into component parts improves
analysis

Conclusions and Actions
–
–
–

After determining reasons for variances, managers
need to draw conclusions about what happened
Determine if corrective action is required
Must consider behavioral implications and employee
incentives to ensure standards are promoting overall
success

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 8


Q3: Direct Cost Variances
•

•

A price variance is the difference between
the standard cost of resources purchased

(or that should have been consumed) and
the actual cost.
An efficiency variance measures whether
inputs were used efficiently.
•

It is the difference between the inputs used
and the inputs that should have been used,
times the standard price of the input

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 9


Q3: Direct Cost Variances

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 10


Q3: Direct Labor Cost Variances
•

•

•

The direct labor price and efficiency variances are
a decomposition of the direct labor flexible budget
variance.
The year-end flexible budget direct labor cost is
based on the standard direct labor hours for the

actual output, or standard quantity allowed (SQA).
Other abbreviations used:
•
SP = standard price of the input
•
AP = actual price of the input
•
AQ = actual quantity of the input used

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 11


Q3: Direct Labor Cost Variances
The direct labor price and efficiency variances are a
decomposition of the direct labor flexible budget variance.
Year-end flexible
budget

Year-end
actual results

SQA x SP

AQ x SP

AQ x AP

DLEV = [SQA – AQ] x SP

DLPV = [SP – AP] x AQ

DL efficiency variance

DL price variance

DL flexible budget variance
© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 12


Q3: Direct Labor Cost Variances Example
Matthews Manufacturing makes a product that is expected to use ¼ hour
of direct labor to produce. At the beginning of the year Matthews
expected to produce 10,000 units. Actual production, however, was 9,800
units. The standard price of direct labor is $10/hour. Actual direct labor
costs were $24,696 for the 2,520 labor hours used. Compute the direct
labor cost variances.
First compute SQA for direct labor:
SQA = 9,800 units x ¼ hour/unit = 2,450 hours
Then compute AP for direct labor:
AP = $24,696/2,520 hours = $9.80/hour
DLPV = [SP – AP] x AQ = [$10/hour - $9.80/hour] x 2,520 hours = $504F
DLEV = [SQA – AQ] x SP = [2,450 hours - 2,520 hours] x $10/hour = $700U
Note that the DL FBV = $504F + $700U = $196U
© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 13


Q4: Direct Labor Cost Variances Example
What are some possible explanations for the direct labor cost variances of
Matthews Manufacturing?
•

•

The favorable price variance could be due to:
•

an incorrect standard price,

•

using a higher percentage of lower-paid workers than expected, or

•

a favorable renegotiation of a labor contract.

The unfavorable efficiency variance could be due to:
•

an incorrect standard quantity for labor,

•

inefficiency of direct labor personnel,

•

unexpected problems with machinery, or

•

lower quality of inputs that were more difficult to use.

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 14


Q3: Direct Material Cost Variances
•

•

•

•

The direct materials and direct labor efficiency
variances are computed in the same fashion.
The direct material price variance is computed
slightly differently than the direct labor price
variance.
Direct materials can be purchased and stored, and
direct labor is consumed as it is purchased.
The direct materials price and efficiency variances
do not sum to the direct material flexible budget
variance when there are any direct materials
inventories.

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 15

Q3: Direct Material Cost Variances
The direct material price variance is based on the actual quantity of direct
materials purchased, not the actual quantity of direct materials used.
Year-end flexible
budget
SQA x SP

AQ x SP

DMEV = [SQA – AQ] x SP

DM efficiency variance
Actual Quantity
Purchased x SP

Remember that
AQ=Actual quantity
used, not actual quantity
purchased.

Actual Quantity
Purchased x AP

DMPV = [SP – AP] x Actual Quantity
Purchased

DM price variance
© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 16

Q3: Direct Material Cost Variances Example
Matthews Manufacturing makes a product that is expected to use 2
pounds of direct material to produce. At the beginning of the year
Matthews expected to produce 10,000 units. Actual production, however,
was 9,800 units. The standard price of direct materials is $3/pound.
Matthews purchased 20,500 pounds of direct material at $3.10/pound,
and used 19,400 pounds. Compute the direct material cost variances.
First compute SQA for direct materials:
SQA = 9,800 units x 2 pounds/unit = 19,600 pounds
DMPV = [SP – AP] x Actual Quantity Purchased =
[$3/pound - $3.10/pound] x 20,500 pounds = $2,050U
DMEV = [SQA – AQ] x SP =
[19,600 pounds - 19,400 pounds] x $3/pound = $600F
© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 17


Q4: Direct Material Cost Variances Example
What are some possible explanations for the direct material cost
variances of Matthews Manufacturing?
•

•

The unfavorable price variance could be due to:
•

an incorrect standard price,

•

an unexpected price increase from a supplier, or

•

the purchase of higher quality materials.

The favorable efficiency variance could be due to:
•

an incorrect standard quantity for material,

•

efficient use of direct materials during production, or

•

less waste of direct materials due to higher material quality.

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 18


Q3: Recording Direct Cost Variances
•

•

•

•

The direct material price variance is recorded
when the materials are purchased.
The direct material efficiency variance is
recorded when the materials are used in
production.
The direct labor price and efficiency variances
are recorded when labor is used in production.
Work in process inventory is debited for the
standard cost of the inputs that should have
been used to produce the actual quantity of
outputs (SP x SQA).

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 19


Q3: Recording Direct Labor Cost Variances
The journal entry to record the use of direct labor is:
dr. Work in process inventory
dr. or cr. DLEV
dr. or cr. DLPV
cr. Accrued payroll

SP x SQA
[SQA-AQ] x SP
[SP-AP] x AQ
AP x AQ

Unfavorable variances are debited to the
variance accounts and favorable variances

are credited to the variance accounts.

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 20


Q3: Recording Direct Labor Cost
Variances Example

Prepare a summary journal entry to record the direct labor costs for
Matthews Manufacturing, including the direct labor cost variances. Refer
to slide #8.

dr. Work in process inventory
[2,450 hrs x $10/hr]

24,500

dr. DLEV
700
[(2,450 hrs – 2,520 hrs) x $10/hr]
cr. DLPV
[($10/hr - $9.80/hr) x 2,520 hrs]
cr. Accrued payroll
[given]

504
24,696

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 21

Q3: Recording Direct Material Cost Variances
The journal entry to record the purchase of direct materials is:
dr. Raw materials inventory
dr. or cr. DMPV
cr. Accounts payable

SP x Actual Qty Purch’d
[SP–AP] x Actual Qty Purch’d
AP x Actual Qty Purch’d

The journal entry to record the use of direct materials is:
dr. Work in process inventory SP x SQA
dr. or cr. DMEV
[SQA-AQ] x SP
cr. Raw materials inventory

SP x AQ

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 22


Q3: Recording Direct Material Cost
Variances Example

Prepare summary journal entries to record the purchase and the use of direct
material for Matthews Manufacturing, including the direct material cost variances.
Refer to slide #12.

The journal entry to record the purchase of direct materials is:

dr. Raw materials inventory [$3/lb x 20,500 lbs]
dr. DMPV [($3/lb –$3.10/lb) x 20,500 lbs]
cr. Accounts payable [$3.10/lb x 20,500 lbs]

61,500
2,050
63,550

The journal entry to record the use of direct materials is:

dr. Work in process inventory [$3/lb X 19,600 lbs] 58,800
cr. DMEV [(19,600 lbs – 19,400 lbs) x $3/lb]
600
cr. Raw materials inventory [19,400 lbs x $3/lb]
58,200
© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 23


Q5: Allocating Overhead Costs
•

•

Chapter 5 covered the allocation of overhead to
units of production.
Estimated overhead rates are calculated for both
fixed and variable overhead.

Standard

variable
overhead
allocation rate

Estimated variable overhead costs
= Estimated volume of an overhead allocation base

Standard fixed
overhead
=
allocation rate

Estimated fixed overhead costs
Estimated volume of an overhead allocation base

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 24


Q5: Overhead Cost Management
•

•

•

For both variable and fixed overhead, cost
management includes reducing non-value-added
costs.
For each variable overhead cost pool, cost
management includes reducing the consumption of

the related cost allocation base.
For fixed overhead, cost management involves a
trade-off between insufficient and excess capacity.

© John Wiley & Sons, Chapter 11: Standard Costs and Variance Slide # 25