Study Notes on Standard Costing and Variance Analysis

Managerial Accounting: Standard Costing and Variance Analysis

Chapter Objectives

• By the end of this chapter, you should be able to:

  • 10.01 Explain the fundamental elements of a standard cost system.

  • 10.02 Describe the basic concepts underlying variance analysis.

  • 10.03 Explain how material and labor variances are calculated and used for control.

  • 10.04 Explain how variable overhead variances are calculated and used for control.

Unit Standards and Basic Concepts of Standard Costing

• Budgets and Standards:

  • Budgets set standards used to control and evaluate managerial performance.

  • To determine the unit standard cost for a particular input, two decisions must be made:

  • Quantity Decision: Amount of input that should be used per unit of output.

  • Pricing Decision: Amount that should be paid per unit of the input to be used.

Quantity and Price Standards

• Standards Development:

  • Quantity decision leads to the development of quantity standards.

  • Pricing decision leads to the establishment of price standards.

• Unit Standard Cost Calculation:

  • The unit standard cost can be computed using the formula:

  • $\text{Standard Cost per Unit} = \text{Quantity Standard} \times \text{Price Standard}$

How Standards Are Developed

• Sources of Quantitative Standards:

  • Historical Experience: Provides initial guidelines for setting standards but may perpetuate inefficiencies if not used carefully.

  • Engineering Studies: Identify efficient approaches and rigorous guidelines, but may result in overly stringent standards.

  • Input from Operating Personnel: Essential since operating personnel are responsible for meeting standards and should contribute to their establishment.

Types of Standards

• Standards are classified as:

  • Ideal Standards: Demand maximum efficiency, achievable only if everything operates perfectly.

  • Currently Attainable Standards: Can be achieved under efficient operating conditions, allowing for normal breakdowns and imperfections.

• Behavioral Benefits:

  • Currently attainable standards offer the most behavioral benefits as they set realistic expectations.

Adoption of Standard Cost Systems

• Reasons for Adoption:

  • Improving Planning and Control:

  • Comparing actual costs with budgeted costs identifies variances:

    • Variance: The difference between actual and planned costs at the actual level of activity.

    • Overall variances can be further broken down into price variance or usage (efficiency) variance if standards have been established.

  • Facilitating Product Costing:

  • Costs assigned to products using quantity and price standards for all manufacturing costs: direct materials, direct labor, and overhead.

  • Strong ethical implications related to cost control and performance evaluation.

Cost Assignment Approaches

• Types of Costing Systems:

  • Standard Costing System: Utilizes standard costs.

  • Normal Costing System: Uses actual costs for direct materials and labor, budgeted overhead.

  • Actual Costing System: Utilizes actual costs for all components.

Standard Product Costs

• Components:

  • Standard costs are developed for:

  • Direct materials

  • Direct labor

  • Overhead

  • Standard cost sheet provides production data for calculating the standard unit cost.

The Standard Cost Sheet

• The standard cost sheet:

  • Shows the quantity of each input required to produce one unit of output.

  • Allows managers to compute standard quantity of materials allowed (SQ) and standard hours allowed (SH) for actual output:

  • $\text{SQ} = \text{Unit Quantity Standard} \times \text{Actual Output (for Direct Materials)}$

  • $\text{SH} = \text{Unit Labor Standard} \times \text{Actual Output (for Direct Labor and Variable Overhead)}$

Variance Analysis: General Description

• Understanding variance calculations will aid in operational control.

• Actual Input Cost Calculation:

  • $\text{Actual Cost} = AP \times AQ$

  • Where:

    • AP = Actual Price per Unit

    • AQ = Actual Quantity of Input Used

• Planned Cost Calculation for Actual Activity Level:

  • $\text{Planned Cost} = SP \times SQ$ where:

  • SP = Standard Price per Unit

  • SQ = Standard Quantity of Input Allowed for Actual Output

Total Budget Variance

• Definition:

  • Total budget variance is defined as the difference between the actual cost of input and its planned cost:

  • $\text{Total Variance} = \text{Actual Cost} - \text{Planned Cost}$

  • Which expands to:

  • $= (AP \times AQ) - (SP \times SQ)$

• Attribution of Responsibility:

  • Responsibility for deviations from planned prices is generally within the purchasing or personnel department.

  • Responsibility for deviations from planned usage tends to lie with the production department.

Price and Usage Variances

• Definition of Variances:

  • Price variance (rate variance) is calculated as:

  • $\text{Price Variance} = (AP - SP) \times AQ$

  • Usage variance (efficiency variance) is calculated as:

  • $\text{Usage Variance} = (AQ - SQ) \times SP$

Unfavorable and Favorable Variances

• Definitions:

  • Unfavorable (U) variances occur whenever actual prices or usage exceed standard prices or usage.

  • Favorable (F) variances occur when actual prices or usage are below the standard prices or usage.

  • The terms favorable and unfavorable do not equate to good or bad variances; they simply show the relationship of actual figures to the standard figures.