Welcome to ACCG200

Lecture 12

Standard costs for control
Chapters 10 and 11 p.519-531

1
Standard costs for control
Standard costs are benchmarks or "norms for measuring
performance and controlling costs. In management
accounting, two types of standards are commonly used.
Quantity standards
specify how much of an
input should be used to
make a product or
provide a service.
Price standards
specify how much
should be paid for
each unit of the
input.
Standard costs for control
A standard is the
expected cost for one
unit.
A budget is the expected
cost for all units
produced.
What is the difference
between standards
and budgets?
Setting Standard Costs
Should we use
ideal standards that
require employees to
work at 100 percent
peak efficiency?
Engineer
Management Accountant
I recommend using practical
standards that are currently
attainable with reasonable
and efficient effort.
Type of Product Cost
A
m
o
u
n
t

Direct
Labor
Standard
Favorable versus Unfavorable
Variances
This variance is unfavorable
because the actual cost
exceeds the standard cost.
Direct
Material
These variances are favorable
because the actual cost
is less than the standard cost.
Manufacturing
Overhead
Standard Costs
Direct
Material
Deviations from standards deemed significant
are brought to the attention of management, a
practice known as management by exception.
Type of Product Cost
A
m
o
u
n
t

Direct
Labor
Manufacturing
Overhead
Standard

Determine cost variances


Three basic parts/steps:

1. A standard cost is developed
A standard cost is a budgeted cost of one unit of product, including
cost of material, labour and overhead.

2. The actual cost incurred in the product process is measured

3. The actual cost is compared to the standard cost to determine a
cost variance

7
Standard cost variances
Direct material standards
Direct Material Quantity Variance
Direct Material Price Variance
Direct labour Standards
Direct Labour Efficiency Variance
Direct Labour Rate Variance
Variable overhead standards
Variable overhead efficiency variance
Variable overhead spending variance
Fixed overhead standards
Fixed overhead budget variance
Fixed overhead volume variance
8
Direct material standards
Standard material quantity
The total amount of direct material normally required
to produce one unit of product

Standard material price
The total delivered cost of per unit of direct material
after subtracting any quantity discounts
9
A General Model for Variance
Analysis
Variance Analysis
Price Variance
Difference between
actual price and
standard price
Quantity Variance
Difference between
actual quantity and
standard quantity
Direct material variances
1) Direct Material (Purchase) Price Variance

Caused by the difference between
the actual price paid for materials and
the budgeted (standard) price that we anticipated.

= PQ(AP SP)

Where PQ = quantity purchased
AP = actual price
SP = standard price

11
Direct material variances (cont.)
2) Direct material quantity variance

A measure of the effect on cost of using a different quantity of
material in production compared with the standard quantity that
should have been used for the actual production output

= SP(AQ SQ)

Where SP = standard price
AQ = actual quantity used
SQ = standard quantity used, given actual output

12
SQ per unit of output Actual output
Lecture Example 1
Johnson Ltd manufactures a single product, A. The standard cost
specification sheet shows the following for one unit of A:

13
6 kg of material X @ $15/kg $90
Actual costs incurred in July when 10000 units of A were produced
were:
67000 kg of material were purchased at $16.50/kg
59000 kg of material were used

Required:
a)Calculate the Direct Material Price Variance
b)Calculate the Direct Material Quantity Variance
a) The Direct Material Price Variance
= PQ (AP SP)
= 67000 (16.5 - 15)
= $100 500

Is this variance favourable or unfavourable? Unfavourable

b) The Direct Material Quantity Variance
= SP (AQ SQ)
= 15 (59000 6 10000)
= $15000

Is this variance favourable or unfavourable? Favourable

Lecture Example 1 - Solution


Materials Price Variance Materials Quantity Variance
Production Manager Purchasing Manager
The standard price is used to compute the quantity variance
so that the production manager is not held responsible for
the purchasing manager's performance.
Responsibility for Materials
Variances
I am not responsible for
this unfavorable materials
quantity variance.
You purchased cheap
material, so my people
had to use more of it.
Your poor scheduling
sometimes requires me to
rush order materials at a
higher price, causing
unfavorable price variances.
Responsibility for Materials
Variances
Production Manager Purchasing Manager
Direct labour variances
1) Direct labour rate variance

Caused by the difference between
the actual labour rate we paid for employees and
the budgeted (standard) labour rate anticipated

= AH(AR SR)

Where AH = actual hours used
AR = actual rate per hour
SR = standard rate per hour

17
Direct labour variances (cont.)
2) Direct Labour Efficiency Variance

Caused by the difference between
the actual hours worked by employees and
the budgeted (standard) labour hours allowed


= SR(AH SH)

Where AH = actual hours used
SH = standard hours allowed, given actual output
SR = standard rate per hour

18
SH per unit of output Actual output
Lecture Example 2
Johnson Ltd manufactures a single product, A. The standard
cost specification sheet shows the following for one unit of A:

19
4 hours of direct labour @ $12.50/hour $50
In July 10000 units of A were actually produced, and 38500
direct labour hours were actually consumed at an average
wage rate of $12.60 per hour

Required:
a) Calculate the Direct Labour Rate Variance
b) Calculate the Direct Labour Efficiency Variance

a) Direct Labour Rate Variance
= AH (AR SR)
= 38500 (12.6 12.5)
= $3850

Is this variance favourable or unfavourable? Unfavourable

Give a possible reason for the direct labour rate variance:

More higher-skilled workers were scheduled than planned.

20
Lecture Example 2 Solutions
b) Direct Labour Efficiency Variance
= SR (AH SH)
= 12.5 (38500 4 10000)
= $18750

Is this variance favourable or unfavourable? Favourable

Provide a reason for the direct labour efficency variance:
1. well maintained machinery
2. Experienced workers
3. High quality of raw materials
4. Budgeted time standards are too loose

21
Lecture Example 2 Solutions Responsibility for Labour
Variances
Production Manager
Production managers are
usually held accountable
for labour variances
because they can
influence the:
Mix of skill levels
assigned to work tasks.
Level of employee
motivation.
Quality of production
supervision.
Quality of training
provided to employees.
I am not responsible for
the unfavorable labor
efficiency variance!
You purchased cheap
material, so it took more
time to process it.
I think it took more time
to process the
materials because the
Maintenance
Department has poorly
maintained your
equipment.
Responsibility for Labor
Variances
Overhead cost variances
Four different overhead variances can be
calculated to compare the actual overhead cost
incurred with the flexible budget:
1. Variable overhead spending variance
2. Variable overhead efficiency variance
3. Fixed overhead budget variance
4. Fixed overhead volume variance

24
Variable overhead cost variances
1) Variable overhead spending variance

A measure of the difference between the actual variable
overhead and the standard variable overhead rate multiplied by
actual activity

= Actual variable overhead (AH ! SVR)

Where
AH = actual direct labour hours/ any other cost driver
SVR = standard variable overhead rate


25
Variable overhead cost variances
2) Variable overhead efficiency variance

A measure of the difference between the actual activity and the
standard activity allowed, given the actual output multiplied by the
standard variable overhead rate

= SVR(AH SH)

Where SH = standard direct labour hours allowed for actual output
AH = actual direct labour hours
SVR = standard variable overhead rate
26
SH per unit of output Actual output
Interpreting variable overhead variances
Spending variance: Actual variable overhead (AH ! SVR)

Actual cost of variable overhead is greater/less than expected, after
adjusting for the actual quantity of cost driver that is used;
Used to control variable overhead cost



Efficiency variance: SVR(AH SH)

The cost effects of excessive or low use of the particular cost driver
Does not measure the efficient or inefficient usage of individual
overhead items.


27
Lecture Example 3
Security Doors has a standard variable overhead rate of $4 per
direct labour hour. The standard quantity of direct labour per unit
of production is 3 hours. The company's static budget was based
on 50,000 units. Actual results for the year are as follows:

Actual units produced 45,000
Actual direct labour hours 120,000
Actual variable overhead $495,000

Calculate the following variances and indicate whether each is
favourable or unfavourable.
a) The variable overhead spending variance
b) The variable overhead efficiency variance

28
a) Variable overhead spending variance?
29
= Actual VOH (AH x SVR)
= 495 000 (120 000 x 4)
= 495 000 480 000
= $ 15 000 UF

Lecture Example 3 - Solution
b) Variable Overhead efficiency variance
= SVR (AH SH)
= 4 x (120 000 3 x 45 000)
= 4 x (120 000 135 000)
= $ 60 000 F


Fixed overhead variances
1) Fixed overhead budget variance
The difference between actual fixed overhead and budgeted fixed
overhead
= actual fixed overhead budgeted fixed overhead

2) Fixed overhead volume variance
The difference between budgeted fixed overhead and fixed overhead
applied to production
= budgeted fixed overhead applied fixed overhead*

* Applied fixed OH= standard fixed OH rate x

30
Standard hours allowed
for actual output
SH per unit of output Actual output
Interpreting fixed overhead variances
Fixed overhead budget variance
(actual fixed overhead budgeted fixed overhead)
Assumes fixed overhead will not change as activity
varies
Real control variance for fixed overhead costs

Fixed overhead volume variance
(budgeted fixed overhead applied fixed overhead)
Provides information capacity utilisation
Does not provide useful information for controlling
fixed overhead costs


31
Lecture Example 4
CB company has set the following standard cost per unit
for 2011:
Fixed overhead: 4 machine hours @ $10 per machine hour

The standards were set based on a capacity of 20000
machine hours.

During the year 6000 units were produced.

Actual fixed overhead was $205,000.

Calculate the following variances and indicate whether
each is favorable or unfavourable:
1. Fixed overhead budget variance
2. Fixed overhead volume variance


1. Fixed overhead budget variance
= Actual FOH Budgeted FOH
= 205 000 10 x 20 000
= 205 000 200 000
= $ 5000 UF

2. Fixed overhead volume variance
= budgeted fixed overhead applied fixed overhead
= 200 000 10 x (4 x 6000)
= 200 000 240 000
= $40 000 F

33
Lecture Example 4 - Solution
Lecture example 5
Broome Instruments Company manufactures a control
valve used in air-conditioning systems. The manufacturing
overhead rate is based on a normal annual activity level of
600 000 machine hours. The company planned to produce
25 000 units each month during 2011. The budgeted
manufacturing for 2011 is as follows:

Variable: $3600 000
Fixed: 3000 000
Total $6 600 000
34
Lecture example 5 cont.
During November, the company produced 26 000 units and used 53 500
machine hours. Actual manufacturing overhead for the month was $260
000 fixed and $320 000 variable. The total manufacturing overhead applied
during November was $572 000. The standard cost of a control valve is as
follows:

Direct material $14.50
Direct labour (2 hrs @ $ 8) 16.00
Manufacturing OH (2 mhrs @ $11) 22.00
Total standard cost $ 52.50

Required: 1) calculate the standard variable overhead rate and standard
fixed overhead rate;
2) calculate the variable and fixed overhead variances for
November and indicate whether each variance is
favourable or unfavourable.

35
Lecture example 5 solutions
1) Standard variable overhead rate
= total budgeted variable overhead/ total budgeted machine hrs
= 3600 000/ 600 000
= $ 6/Mhr

Standard fixed overhead rate
= total budgeted fixed overhead/ total budgeted machine hrs
= 3000 000/ 600 000
= $5/Mhr

36
Lecture example 5 solutions
2)Variable overhead spending variance
37
= Actual VOH (AH x SVR)
= 320 000 (53 500 x 6)
= 320 000 321 000
= $ 1000 F


Variable Overhead efficiency variance
= SVR (AH SH)
= 6 x (53 500 2 x 26 000)
= 6 x (53 500 52 000)
= $ 9 000 UF

Lecture example 5 solutions
Fixed overhead budget variance
= Actual FOH Budgeted FOH
= 260 000 3000 000/12
= 260 000 250 000
= $ 10 000 UF

Fixed overhead volume variance
= budgeted fixed overhead applied fixed overhead
= 250 000 5 x (2 x 26 000)
= 250 000 260 000
= $10 000 F

38
Investigating significant variances and
taking corrective actions
Management by exception
Only significant cost variances are reported and
investigated

Which variances are significant?
Size of variance
Recurring variances
Trends
Controllability
39
Behavioural impact of standard
costing
Standard costing can be used to evaluate the
performance of managers, employees and departments.

Comparing individuals' performance with standards or
budgets can be used to determine salary increases,
bonuses and promotions.

These practices can profoundly influence behaviour.
Motivate positive behaviours;
Encourage the manipulation of data and reports and
dysfunctional activities and decisions.

40
Standard costs for product costing
Standard costing system
All inventories are recorded at standard cost

Variances are closed off at the end of the
accounting period
To cost of goods sold expense
Prorate variances between WIP, FG and COGS,
if significant
10-41
Additional question
Number of units produced ......................................................... 28,000
Actual direct labour-hours worked............................................. 60,000
Actual variable manufacturing overhead cost incurred............. $163,000
Actual fixed manufacturing cost incurred.................................. $221,000
42
Lower Hut Company produces a single product that requires a large amount oI
labour time. Overhead cost is applied on the basis oI standard direct labour
hours. Variable manuIacturing overhead should be $3.00 per standard direct
labour hour and Iixed manuIacturing overhead should be $210,000 per year.

The product requires 2 hours oI direct labour time. During the year, the
company had planned to operate at an activity oI level oI 50,000 direct labour
hours and to produce 25,000 units oI product. Actual activity and costs Ior the
year were as Iollows:

a) Variable overhead spending variance
43
= Actual VOH (AH x SVR)
= 163 000 (60 000 x 4)
= $ 17 000 F

Solutions
b) Variable Overhead efficiency variance
= SVR (AH SH)
= 3 x (60 000 2 x 28 000)
= 3 x (60 000 56 000)
= $ 12 000 UF


Solutions
c) Fixed overhead budget variance
= Actual FOH Budgeted FOH
= 221 000 210 000
= $ 11 000 UF

d) Fixed overhead volume variance
= budgeted fixed overhead applied fixed overhead
= 210 000 FOH Rate x (2 x 28 000)
= 210 000 (210 000/50 000) x 56 000
= 210 000 235 200
= $ 25 200 F

44