Standard Costing and Variance Analysis

How to solve for purchases?

units sold (given) + ending inventory - beginning inventory

Budgets are used for ________ and _________

planning and control

Budgets are helpful for planning bur budgets can also be used as _____ _____ _______________________________________

reference points, benchmarks, for evaluating actual performance 

Control 

• managers should be held responsible for items and decisions they can significantly control

• performance relative to budgeters can impact job retention, promotions, and bonuses 

Standard in general terms

a budgeted or benchmark amount per unit or per input

• reflects what management believes amounts should be

• set before the start of the budget period

How are standards set

• past experiences

• analysis of historical data

• time and motion studies

Why are standards used

Using standards helps maintain consistency and quality in the prediction process

• Budgeted costs are based on the standard costs for inputs multiplied by a specific level of output

Attainability of standards

ideal standards

• Assume perfect operation conditions.

• Assume relativistic operating conditions.

• Allows a reasonable amount of downtime for productive maintenance, employee breaks, training, etc

Budget Timelines

Planning: master (planning) budget

• prepared in advance

Implementation: budget period

Control: flexible budget

• prepared after actual results are known

Master (planning) Budget

a strategic budget based on budgeted (estimated) output (units produced and sold)

• prepared during the planning stage before actual results are known

• uses standards in calculating total budgeted amounts 

Flexible Budget

a revised budget that adjusts for actual output (units produced and sold)

• prepared during the control stage, by adjusting the planning budget for actual output (units produced and sold)

• separates the effect of spending (cost control) from the effects of sales volume

Master (planning) Budget Formula

budgeted output x standard quantity x standard price = master budget amount

Flexible Budget Formula

actual output x standard quantity x standard price = flexible budget amount

Actual Results Formula

actual output x actual quantity x actual price = actual amount

What is the difference between the master and flexible budget formula

difference in output

What is the difference between the flexible and actual results budget

difference in other factors

What is the difference between the master budget and actual results

difference due to output and other factors

What is a variance

the difference between what was planned (budgeted) and what actually happened (actual results)

Why do variances occur?

• differences in prices or costs

• differences in efficiency or usage

• difference in volume or activity levels

• inaccurate standards or budgeting assumptions

• other factors ——-ex: process disruptions

How are variances used

Variance analysis: the comparison of budget expectations and actual performance is used to evaluate and improve performance, provide feedback, and support decision-making and future planning

• Managers need to understand the cause of significant variances (management by exception)

Who is responsible for variances

it depends on who had control over the amounts being measured 

Every variance must be labeled either ______ or _____ based on how it affects short term operating profit

favorable or unfavorable

Notes on variances 

• A favorable variance is not always good, and an unfavorable variance is not always bad

• It’s important to understand the reason for the variance

• Variances that are favorable in the short run may be unfavorable in the long run

Cost

favorable: actual costs < standard costs

unfavorable: actual costs > standard costs

Revenue

favorable: actual revenues > standard revenues

unfavorable: actual revenues < standard revenues

Flexible Budget

• separates the effect of spending (cost control) from the effects of sales volume

• prepared during the control stage, by adjusting the planning budget and actual output (units produced and sold)

• A flexible budget shows the expected total revenues and costs at the actual level of output (units produced and sold)

Notes on Flexible Budgets

• Fixed costs on the flexible budget are the same as on the master budget.

• All per-unit assumptions for revenue and variable cost are the same as on the master budget

Volume Variances

master planning budget vs flexible budget

• Volume variances are calculated by comparing the master budget (based on budgeted output) to the flexible budget (based on actual output)

• Both the master budget and flexible budgets are based on the SAME STANDARD UNIT COSTS, so any DIFFERENCE is due to the difference in OUTPUT (units produced and sold)

• Sometimes referred to as activity variances or sales volume variances, addressed the effect that a change in volume (activity) has on revenues, costs, and profit

Volume Variance Note

The master planning budget is only used to compute volume variances, which are not the same as quantity variances

• Quantity variance is based on the amount of input that was used to produce the actual level of output, while the volume variance is the difference between actual and budgeted output

For what purpose is a flexible budget used?

to identify the sources of variances (improve budgets moving forward)

Revenue and Spending Variances

flexible budget vs actual results

• Revenue and spending variances are calculated by comparing actual revenues and costs to the flexible budget, which is based on actual output (units produced and sold)

• Because the flexible budget is adjusted for actual production volume, any variance is due to the selling price or the amount spent on DM, DL, or OH.

• These variances answer the question: How well did we control revenue, costs, and profit (based on actual output)

Revenue (sales price) variance

The difference between actual revenue and the flexible budget

• actual revenue and the flexible budget are both based on actual output (units produced and sold)

Spending variance

The difference between actual costs and the flexible budget

• Actual costs and the flexible budget are both based on actual output (units produced and sold)

Spending variances occur due to some combination of differences between

• standard quantity vs actual quantity

• standard price vs actual price

What can cause a sales price variance

• price discounts

• price competition

• increased quality

• high inflation

Sales price (revenue) variance formula

sales price (master budget) 

-sales price (actual results)

=difference in sales price x actual sales volume = sales price variance 

Spending variances

the spending variance can be decomposed into a price (rate) variance and a quantity (efficiency) variance

Price (Rate) Variance

difference between

• the actual cost of the actual quantity of inputs used

• and what should have been paid for the actual quantity of inputs used at the standard (budgeted) price

• measures how well the price was controlled

Quantity (Efficiency) Variance

difference between

• the actual quantity of inputs used at the budgeted/standard price and the quantity of inputs that should have been used at the standard (budgeted) price

• measures how efficiently resources were used 

Types of cost standards (for more detailed variances)

• Quantity standards represent the amount of input that should go into a single unit of output (completed product)

• Price standards represent the price that should be paired for a specific quantity of input

Standards are expressed in terms of ________

inputs

Standards are stated in terms of the quantity and the price of inputs that should be used to create a single unit of output

true

Budgets are expressed in terms of _______

output

• the total dollar amount we expect to spend to achieve a given level of output

Standard price per unit

amount that should be paid for a particular quantity of input 

standard quantity (allowed) of input per unit of output

amount of input that should be used to produce a single unit of output

actual price per input

the actual price for a particular quantity of input

actual quantity of input per unit of output

the actual amount of input used for a single unit of output

Materials Price Variance Formula

AQ x (AP - SP)

Materials Quantity Variance Formula

SP x (AQ-SQ)

Materials Spending Variance Formula

(AQ x AP) - (SQ x SP)

Labor Rate Variance Formula

AH x (AR - SR)

Labor Efficiency Variance Formula

SR x (AH - SH)

Labor Spending Variance Formula

(AH x AR) - (SH x SR)

SQ

actual output (units) x standard amount of input per unit

AQ

actual output (units) x actual amount of input per unit

SP and AP represent

the price (rate) per input

Direct Materials Price Variance Formula 

AQ x (AP - SP)

Direct Materials Quantity Variance Formula

SP x (AQ - SQ)

Direct Labor Rate Variance Formula

AH x (AR - SR)

Direct labor Efficiency Variance Formula 

SR x ( AH - SH)

Who is responsible for the materials price variance

purchasing manager 

• quality of materials, cost of materials, volume discounts 

Who is responsible for material quantity variance

production manager

• worker training/experience, supervision, equipment issues

Who is responsible for the direct labor rate variance

hiring manager and production manager

• hiring efforts, negotiation

Who is responsible for direct labor efficiency variance 

production manager

• worker training/experience, supervision, assignment to tasks 

After analyzing variances, companies will evaluate and take various corrective actions such as

• investigate all significant variances (management by exception)

• Identify trends and other patterns

• consider the big picture

• don’t get lost in the calculations

• Look at the connections between variances