ACCY 309 ch.7

Variances

*Occur when the actual price or quantity amounts differ from standard

Standard Costing

-Traces direct costs to output produces

Under Standard Costing:

-Variances recorded in accounting system -Favorable Variances:Credits,Represent savings in production costs -Unfavorable Variances:Debits,Represents excess production costs -Inventories are recorded at standard cost during the period

Advantages of Standard Costing

-helps managers control the organization -Facilitates planning and the budgeting process -May help evaluate manager performance

Three Primary Uses of A Standard Cost System

1.Assign per unit costs to production to value inventory 2.Control overhead spending 3.Measure and evaluate the use of production capacity with respect to the incurrence of fixed overhead costs

Clerical efficiency

A company that uses standard costs to trace the flow of costs through its accounting system usually discovers that less clerical time and effort are required than in an actual cost system

Management by Exception

A manager only investigating significant deviations from the standard. -Both upper and lower limits of acceptability are set; managers are reasonably unconcerned with deviations within the range of acceptability. _If a cost or quantity falls outside either of these limits, a manager should discuss the deviation with the person responsible and attempt to correct (if necessary) the situation. *a standard cost system is useful in this case, because the standard costs and quantities set the norm from which to judge the degree of acceptability of variances. -EXAMPLE: Management could set the "exception" policy as 5% above or below standard to indicate the operational areas in need of attention.

Considerations in Establishing Standards

Appropriateness and Attainability

Quality Standard

Based on a consideration of trade-offs between higher quality and, potentially, higher cost of inputs.

Material Standards

Based on both quality and quantity of materials

Quantity Standards

Based on physical quantities used in the past, engineering studies, improvements expected in handling or usage, and normal waste and spoilage allowances.

Why are standard cost systems used?

Clerical efficiency, motivation, planning, controlling, decision making, performance evaluation

Operations Flow Document

Details all necessary operations to make a unit of output or summarizes the time to make one unit of output.

Standard Valuation, Unit Norms/Benchmarks, "Standards" -->Used for STANDARD COSTING

Developed for Direct Material (DM), Direct Labor (DL), and Overhead (OH). *Applied using a standard predetermined rate *Allows companies to quickly identify deviations from expected costs.

How are material, labor, and overhead variances calculated and recorded?

General Variance Analysis Model

"Unfavorable" Variances

If the actual price or quantity amounts are higher than the standard price or quantity amounts. *Do not necessarily equate good and bad performance

Labor Efficiency Variance (LEV)

Indicates whether the amount of time worked was less than or more than the standard quantity for the actual output

Planning

Managers can use currently available standard costs to estimate future quantities and costs

Attainability, in relation to a standard

Refers to management's belief about the degree of difficulty or rigor that should be incurred in achieving the standard. Standards can be classified by their degree of rigor, and, thus, their motivational value from easy to difficult as follows: Expected Practical Ideal

Appropriateness, in relation to a standard

Refers to the basis on which the standards are developed and how long they are expected to last. -Standards are developed from past and current information, and they should reflect technical and environmental factors expected during the period in which the standards are to be applied. -Factors such as the materials quality, normal ordering quantities of materials, expected employee wage rates, degree of plant automation, facility layout, and mix of employee skills should be considered. -Standards must evolve over the organization's life to reflect its changing methods and processes

Price (or rate) Variance

Reflects the difference between the actual price (AP) paid for inputs and the standard input price (SP) for the actual quantity (AQ) of inputs used during the period: =(AP-SP)(AQ)

Usage (quantity or efficiency) Variance

Shows the difference between the actual quantity (AQ) of inputs used and the standard quantity (SQ) of inputs allowed for the actual output achieved during the period. *Focus on the efficiency of results- the relationship of inputs to outputs =(AQ-SQ)(SP)

Bill of Materials

Specifies the quality and quantity of each raw material needed to complete one unit of output. -Presents minimum quantities needed for production

Decision Making

Standard cost information availability facilitates many decisions.

Motivation

Standards represent a technique of communicating management's expectations of efficiency to workers

Expected Standards

Standards set at a level that reflects what is actually expected to occur in the future period; these standards anticipate future wastes and inefficiencies and allow for them; they are not of significant value for control and performance evaluation purposes.

Practical Standards

Standards that can be reached or slightly exceeded approximately 60 to 70 percent of the time with reasonable effort by workers; the allow for normal, unavoidable time problems or delays and for worker breaks: they are believed to be most effective in inducing the best performance from workers, since such standards represent an attainable challenge.

Ideal Standards

Standards that provide for no inefficiencies of any type, are impossible to attain, and are sometimes called theoretical standards.

Standard Cost Card

Summarizes the direct material, direct labor, and overhead standard quantities and prices needed to complete one unit of output. -Shows the assignment of standard costs to each raw material in the bill of materials to determine the total standard material cost of one unit of output. -Presents more realistic (although not necessarily the most efficient) quantities allowed for production.

Performance Evaluation

Summary variance reports focus attention on the operating performance of subordinate managers, allowing top managers to determine when costs were and were not controlled by which managers. Top managements can then provide vital feedback to the subordinate managers.

Controlling

The control process begins with the establishment of standards which provide a basis against which actual costs can be measured so variances may be computed

Labor Rate Variance (LRV)

The difference between the actual wages paid to labor for the period and the standard cost of actual hours worked

Standard Cost

The expected/budgeted amounts of resources needed to produce a single unit of product or perform a single service.

Material Quantity Variance

The material usage variance when computed based on the quantity of materials used during the period

Material Purchase Price Variance

The materials price variance when computed based on the quantity of materials purchased during the period rather than the quantity of materials used

Standard Quantity (SQ)

The quantity of input that should have been used to achieve the actual output.

Management by Exception

The setting of upper and lower tolerance limits for deviations allows managers to implement this concept.

Standard hours

The standard amount of input time it should take to produce the actual quantity of output generated during the period. -The amount of standard hours refers to the standard time allowed for the production achieved in the period

Total Labor Variance

The summation of the individual variances or can also be calculated by subtracting the total standard cost from the total actual cost

In a General Variance Analysis Model: Total Variance

Total Actual Cost for the Production inputs-Total Standard Cost Applied to the production output *Indicate differences between actual and expected production costs. BUT DO NOT provide useful information for determining why such differences occurred. Thus, total variances are subdivided into price and usage variances in order to help managers accomplish their control objectives. *Can be computed for each production cost element (DM, DL, OH)

Time Details

Used to develop standard labor cost and time and overhead rates for production of one unit of output.

"Favorable" Variances

When the actual price and quantity amounts are lower than the standard *Do not necessarily equate good and bad performance

Point of Purchase Material Variance Model

When the quantity of material purchased is not the same as the quantity of material placed into production, the general variance model can be easily modified to isolate material price variances as early as possible to provide more rapid information to management control purposes. *Calculates the material price variance using the quantity of materials purchased (Qp)

Variance Analysis

involves looking at differences between actual versus standard costs/quantities, categorizing those differences as favorable or unfavorable, and seeking explanations

Variance Analysis

the process of categorizing the nature (FAVORABLE or UNFAVORABLE) of the differences between standard and actual costs and determining the reasons for those differences