Chapter 10: Standard Costs and Variances

Standard Costs and VariancesChapter 10Standard CostsStandards are benchmarks or “norms” formeasuring performance. In managerial accounting,two types of standards are commonly used.Quantity standardsspecify how much of aninput should be used tomake a product orprovide a service.Price standardsspecify how muchshould be paid foreach unit of theinput.Examples: Firestone, Sears, McDonald’s, hospitals, construction, and manufacturing companies.Setting Direct Materials Standards Standard Priceper UnitSummarized in a Bill of Materials.Final, deliveredcost of materials,net of discounts.Standard Quantityper UnitSetting Direct Labor Standards Use time and motion studies foreach labor operation.Standard Hoursper UnitOften a singlerate is used that reflectsthe mix of wages earned.Standard Rateper HourSetting Variable Manufacturing Overhead Standards The rate is the variable portion of the predetermined overhead rate.PriceStandardThe quantity is the activity in the allocation base for predetermined overhead.QuantityStandardA General Model for Variance AnalysisVariance AnalysisQuantity VarianceDifference betweenactual quantity and standard quantityPrice VarianceDifference between actual price andstandard pricePrice and Quantity StandardsPrice and quantity standards are determined separately for two reasons: The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used. The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production. Variance AnalysisMaterials quantity varianceLabor efficiency varianceVOH efficiency varianceA General Model for Variance AnalysisPrice VarianceQuantity VarianceMaterials price varianceLabor rate varianceVOH rate varianceA General Model for Variance AnalysisPrice Variance(2) – (1)Quantity Variance(3) – (2)(3)Standard QuantityAllowed for Actual Output,at Standard Price(SQ × SP)(2)Actual Quantityof Input,at Standard Price(AQ × SP)(1)Actual Quantityof Input,at Actual Price (AQ × AP)Spending Variance(3) – (1)A General Model for Variance AnalysisActual quantity is the amount of direct materials, direct labor, and variable manufacturing overhead actually used.Price Variance(2) – (1)Quantity Variance(3) – (2)(3)Standard QuantityAllowed for Actual Output,at Standard Price(SQ × SP)(2)Actual Quantityof Input,at Standard Price(AQ × SP)(1)Actual Quantityof Input,at Actual Price (AQ × AP)Spending Variance(3) – (1)A General Model for Variance Analysis Standard quantity is the standard quantity allowed for the actual output of the period.Price Variance(2) – (1)Quantity Variance(3) – (2)(3)Standard QuantityAllowed for Actual Output,at Standard Price(SQ × SP)(2)Actual Quantityof Input,at Standard Price(AQ × SP)(1)Actual Quantityof Input,at Actual Price (AQ × AP)Spending Variance(3) – (1)A General Model for Variance Analysis Actual price is the amount actuallypaid for the input used.Price Variance(2) – (1)Quantity Variance(3) – (2)(3)Standard QuantityAllowed for Actual Output,at Standard Price(SQ × SP)(2)Actual Quantityof Input,at Standard Price(AQ × SP)(1)Actual Quantityof Input,at Actual Price (AQ × AP)Spending Variance(3) – (1)A General Model for Variance Analysis Standard price is the amount that shouldhave been paid for the input used.Price Variance(2) – (1)Quantity Variance(3) – (2)(3)Standard QuantityAllowed for Actual Output,at Standard Price(SQ × SP)(2)Actual Quantityof Input,at Standard Price(AQ × SP)(1)Actual Quantityof Input,at Actual Price (AQ × AP)Spending Variance(3) – (1)Materials Price VarianceMaterials Quantity VarianceProduction ManagerPurchasing ManagerThe standard price is used to compute the quantity varianceso that the production manager is not held responsible forthe purchasing manager’s performance.Responsibility for Materials VariancesResponsibility for Labor VariancesProduction ManagerProduction managers areusually held accountablefor labor variancesbecause they caninfluence the:Mix of skill levelsassigned to work tasks. Level of employee motivation.Quality of production supervision.Quality of training provided to employees.Advantages of Standard CostsStandard costs area key element ofthe management byexception approach.AdvantagesStandards canprovide benchmarksthat promote economy and efficiency.Standards can greatly simplifybookkeeping.Standards cansupport responsibilityaccounting systems.PotentialProblemsIf variances are misusedas a club to negativelyreinforce employees,morale may suffer andemployees may make dysfunctional decisions. Standard cost variancereports are usuallyprepared on a monthlybasis and may contain information that isoutdated. Potential Problems with Standard CostsLabor variances assume that the production process is labor-pacedand that labor is a variable cost. These assumptions are often invalidin today’s automated manufacturing environment where employeesare essentially a fixed cost. Excessive emphasis on meeting the standards may overshadow otherimportant objectives such as maintaining and improving quality, on-time delivery, and customer satisfaction.In some cases, a “favorable” variancecan be as bad orworse than anunfavorable variance. Just meeting standardsmay not be sufficient;continuous improvementmay be necessary tosurvive in a competitiveenvironment.Potential Problems with Standard CostsPotentialProblemsEnd of Chapter 10