Accounting 211 Chapter 8 Notes

Using Standard Costs-Direct Materials Variance (p347)

See exhibit 8-11 for an example.

Using Standard Costs-Direct Labor Variance (p351)

See exhibit 8-12 for an example.

Using Standard Costs-Variable MO Variances (p353)

See exhibit 8-13 for example

3 Additional Notes regarding Standard Cost Variance Analysis (p347)

1. First, a quantity variance and a price variance can be computed for each of the three variable cost elements—direct materials, direct labor, and variable manufacturing overhead—even though the variances have different names. For example, a price variance is called a materials price variance in the case of direct materials but a labor rate variance in the case of direct labor and a variable overhead rate variance in the case of variable manufacturing overhead. 2. Second, the quantity and price variances—regardless of what they are called—are computed in exactly the same way regardless of whether one is dealing with direct materials, direct labor, or variable manufacturing overhead. 3. Third, the input is the actual quantity of direct materials or direct labor purchased; the output is the amount of finished goods produced during the period. The--Standard Quantity Allowed for Actual Output--(also called the--Standard Hours Allowed for Actual Output-- when dealing with direct labor and variable overhead) means the amount of an input that should have been used to produce the actual output of the period. This could be more or less than the actual amount of the input, depending on the efficiency or inefficiency of operations. The standard quantity allowed is computed by multiplying the actual output in units by the standard input allowed per unit of output.

Standard Cost Card & Standard Price per Unit (p345)

A Standard Cost Card shows the standard quantities and costs of the inputs required to produce a unit of a specific product. Standard Cost per Unit is the Direct Labor, Direct Materials and MO allocated to each unit.

Revenue Variance (p340)

A revenue variance is the difference between what the total revenue should have been, given the actual level of activity for the period, and the actual total revenue. If actual revenue exceeds what the revenue should have been, the variance is labeled favorable. If actual revenue is less than what the revenue should have been, the variance is labeled unfavorable.

Spending Variance (p341)

A spending variance is the difference between how much a cost should have been, given the actual level of activity, and the actual amount of the cost. If the actual cost is greater than what the cost should have been, the variance is labeled as unfavorable. If the actual cost is less than what the cost should have been, the variance is labeled as favorable.

Standard Costs (p343)

A standard is a benchmark for measuring performance. Standards are also widely used in managerial accounting where they relate to the quantity and cost (or acquisition price) of inputs used in manufacturing goods or providing services. Quantity and price standards are set for each major input such as raw materials and labor time. 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. Actual quantities and actual costs of inputs are compared to these standards. If either the quantity or the cost of inputs departs significantly from the standards, managers investigate the discrepancy to find the cause of the problem and eliminate it.

Setting Variable MO Standards (p345)

As with direct labor, the price and quantity standards for variable manufacturing overhead are usually expressed in terms of rate and hours. The rate represents the variable portion of the predetermined overhead rate discussed in the job-order costing chapter; the hours relate to the activity base that is used to apply overhead to units of product (usually machine-hours or direct labor-hours).

Variance Analysis Cycle (p336)

Companies use the variance analysis cycle to compare budgets to actual results for the purposes of solving problems and evaluating performance. The cycle begins with the preparation of performance reports in the accounting department. These reports highlight variances, which are the differences between the actual results and what should have occurred according to the budget. The variances raise questions and the significant variances are investigated to discover their root causes and corrective actions are taken. Then, next period's operations are carried out and the cycle begins again with the preparation of a new performance report for the latest period. The emphasis should be on highlighting problems, finding their root causes, and then taking corrective action.

Flexible Budgets (p337)

Flexible budgets take into account how changes in activity affect costs. A flexible budget is an estimate of what revenues and costs should have been, given the actual level of activity for the period. When a flexible budget is used in performance evaluation, actual costs are compared to what the costs should have been for the actual level of activity during the period rather than to the static planning budget. This is a very important distinction. If adjustments for the level of activity are not made, it is very difficult to interpret discrepancies between budgeted and actual costs. In contrast, a Planning Budget is prepared before the period begins and is valid for only the planned level of activity.

Flexible Budget Based on Multiple Cost Drivers (p342)

In order to make the flexible budget as accurate as possible it may be necessary to use more than one cost driver to calculate cost or revenue. Example some costs may be driven by direct labor hours while others are driven by units of production. Beyond using more than one cost driver to improve its budgeting and performance analysis process, a company can also decompose its spending variances into two parts—a part that measures how well resources were used and a part that measures how well the acquisition prices of those resources were controlled.

Management by Exception (p 336)

Management by exception is a management system that compares actual results to a budget so that significant deviations can be flagged as exceptions and investigated further. This approach enables managers to focus on the most important variances while bypassing trivial discrepancies between the budget and actual results.

Labor Rate Variance (p352)

Measures the difference between the actual hourly rate and the standard rate, multiplied by the actual number of hours worked during the period Formula to Calculate LRV: Labor rate variance = AH(AR − SR) Where: AH = Actual quantity of hours used in production AR = Actual rate per direct labor hour SR = Standard rate per direct labor hour

Labor Efficiency Variance (p351)

Measures the difference between the actual hours taken to complete a task and the standard hours allowed for the actual output, multiplied by the standard hourly rate. Formula to Calculate LEV Labor efficiency variance = (AH − SH)SR Where: AH = Actual quantity of hours used in production SH = Standard quantity of hours allowed for the actual output SR = Standard rate per direct labor hour

Variable Overhead Efficiency Variance (p354)

Measures the difference between the actual level of activity and the standard activity allowed, multiplied by the variable part of the predetermined overhead rate. Formula to Calculate VOHEV: Variable overhead efficiency variance = (AH − SH)SR Where: AH = Actual quantity of hours used in production SH = Standard quantity of hours allowed for the actual output SR = Standard rate per direct labor hour

Materials Price Variance (p349)

Measures the difference between the actual price per unit of an input and its standard price, multiplied by the actual quantity purchased. Formula to Calculate MPV: Materials price variance = AQ(AP − SP) Where: AQ = Actual quantity of pounds purchased for production AP = Actual price per unit of the input SP = Standard price per unit of the input

Materials Quantity Variance (p348)

Measures the difference between the actual quantity of materials used in production and the standard quantity allowed for the actual output, multiplied by the standard price per unit of materials. It is labeled as unfavorable (favorable) when the quantity of materials used in production is greater than (less than) the quantity that should have been used according to the standard. Formula to Calculate MQV: Materials quantity variance = (AQ − SQ)SP Where: AQ = Actual quantity of pounds purchased and used in production SQ = Standard quantity of pounds allowed for the actual output SP = Standard price per unit of the input

Variable Overhead Rate Variance (p354)

Measures 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. Formula to Calculate VOHRV: Variable overhead rate variance = AH(AR - SR) Where: AH = Actual quantity of hours used in production AR = Actual rate per direct labor hour SR = Standard rate per direct labor hour NOTE: The AR is calculated by taking the Total Variable OH / Actual Hours

Overhead Application in a Standard Cost System (p382)

Overhead is applied to work in process on the basis of the standard hours allowed for the actual output of the period rather than on the basis of the actual number of hours worked. In a standard cost system, every unit of a particular product is charged with the same amount of overhead cost, regardless of how much time the unit actually requires for processing.

Predetermined Overhead Rate (POR) and Overhead Analysis in a Standard Costing System (p381)

POR = Est. Total MO / Est. Total Amt of Allocation Base Denominator Activity is another term for the Total Amount of the Allocation Base. If the Budgeted Overhead is broken down into Fixed and Variable costs these can be divided by the Denominator Activity to determine Fixed and Variable Overhead costs per unit.

Standard Cost Variance Analysis (p346)

Standard cost variance analysis decomposes spending variances from the flexible budget into two elements—one due to the amount of the input that is used and the other due to the price paid for the input. The reason standards are separated into two categories—quantity and price is Quantity Variances and Price Variances usually have different causes. In addition, different managers are usually responsible for buying and for using inputs. A Quantity Variance is the difference between how much of an input was actually used and how much should have been used and is stated in dollar terms using the standard price of the input. A Price Variance is the difference between the actual price of an input and its standard price, multiplied by the actual amount of the input purchased.

Using Standards in Flexible Budgets (p345)

Standards can be used in the computations of the Flexible Budget line items to compare to the actual to measure the variances. Note: When calculating totals for materials, labor & OH on a flexible budget you multiply the Standard Rate by the actual units of output.

Budget Variance (p383)

The difference between the actual fixed manufacturing overhead and the budgeted fixed manufacturing overhead for the period. Budget Variance = Actual Fixed Overhead - Budgeted Fixed Overhead If the actual fixed overhead cost exceeds the budgeted fixed overhead cost, the budget variance is labeled unfavorable. If the actual fixed overhead cost is less than the budgeted fixed overhead cost, the budget variance is labeled favorable.

Standard Hours per Unit

The standard direct labor time required to complete a unit of product. It is the most difficult standard to determine. The standard time should include allowances for breaks, personal needs of employees, cleanup, and machine downtime.

Standard Price per Unit (p344)

The standard price per unit for direct materials should reflect the final, delivered cost of the materials.

Standard Quantity per Unit (p344)

The standard quantity per unit for direct materials should reflect the amount of material required for each unit of finished product as well as an allowance for waste.

Standard Rater per Hour (p344)

The standard rate per hour for direct labor should include hourly wages, employment taxes, and fringe benefits.

Volume Variance (p384)

The variance that arises whenever the standard hours allowed for the actual output of a period are different from the denominator activity level that was used to compute the predetermined overhead rate. It is computed by multiplying the fixed component of the predetermined overhead rate by the difference between the denominator hours and the standard hours allowed for the actual output. Volume Variance = Budgeted Fixed Overhead - Fixed Overhead Applied to WIP When the budgeted fixed manufacturing overhead exceeds the fixed manufacturing overhead applied to work in process, the volume variance is labeled as unfavorable. When the budgeted fixed manufacturing overhead is less than the fixed manufacturing overhead applied to work in process, the volume variance is labeled as favorable.

Important Subtlety in the Materials Variances (p356)

When the Quantity of Materials Purchased is different from the Quantity Materials Used in Production the: Materials Price Variance is computed using the Quantity of Materials Purchased. Materials Quantity Variance is computed using the Quantity of Materials Used. When unused materials are used in future periods a price variance is not computed since it was accounted for in the period purchased, however a quantity variance will be computed. Formula for MQV: Materials quantity variance = (AQ − SQ)SP Where: AQ = Actual quantity of pounds used in production SQ = Standard quantity of pounds allowed for the actual output SP = Standard price per unit of the input Formula for MPV: Materials price variance = AQ(AP − SP) Where: AQ = Actual quantity of pounds purchased AP = Actual price per unit of the input SP = Standard price per unit of the input