(c) ghanendra fago (m. phil, mba) 1 standard costing, variance analysis and management cycle use...

(C) Ghanendra Fago (M. Phil, MBA) 1

Standard Costing, Variance Analysis and Management CycleUse standard costs to prepare budgets and establish goals for product costing.

Apply dollar, time, and quantity standards to work.

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Standard Costs

1. Standard costs are predetermined costs

that are developed from analyses of both:1. a. Past operating costs, quantities, and times

2. b. Future costs and operating conditions.

2. In a standard costing system, standard

costs for direct materials, direct labor, and

manufacturing overhead flow through the

inventory accounts and eventually into the

Cost of Goods Sold account.


The Management Cycle

Managers use standard costs throughout the management cycle:

• In the planning stage of the management cycle, standard costs aid in the development of budgets.

• During the executing stage, standard costs, quantities, and time are applied to work performed.

• During the reviewing stage, actual costs are compared with standard costs to compute variances, and managers analyze the causes of those variances to improve operations.

• During the reporting stage, a variance report provides information on operations and managerial performance


The Management Cycle

In today’s globally competitive environment, new standards or measurements are necessary to help managers:– Reduce processing time. – Improve quality.– Improve customer satisfaction.– Improve on-time deliveries


Standard Costs• Standard costs are used with existing job

order or process costing systems. • Standard costs are usually expressed as the

cost per unit of a finished product or process.

– Standard costs are based on:

– Engineering estimates.

– Forecasted demand.

– Worker input.

– Time and motion studies.

– Type and quality of direct materials


Standard Costing• The technique for application of standard cost is known

as Standard Costing. It is the preparation of standard cost

and applying them to measure the variation between

standard cost and actual cost.

• The preparation of standard costs of products and service

and a technique whereby the planned activities of an

undertaking are expressed in budgets, standard costs,

standard selling price and standard profit margins, and

the differences between these and the comparable actual

results are accounted for.’

• Standard costing is expensive to use because the

management accounting system must keep separate

records of actual costs to compare with what should have

been spent.


Standard costing may be summarized as

• To fix the standard cost for material, labour and overhead.

• To find out the actual cost• To compare the actual cost with standard cost• To analyse the variance between standard

cost and actual cost


Use of Standard Costs Preparing operating budgets.

Identifying production costs and processes that

must be managed to reduce waste and

inefficiency.

Evaluating the performance of managers and

workers.

Setting prices.

Simplifying inventory and product costing

procedures


Standard Cost per UnitThere are six standards used to determine the

standard cost per unit:

1.1. Direct materials price standardDirect materials price standard

2.2. Direct materials quantity standardDirect materials quantity standard

3.3. Direct labor time standardDirect labor time standard

4.4. Direct labor rate standardDirect labor rate standard

5.5. Standard variable manufacturing overhead rateStandard variable manufacturing overhead rate

6.6. Standard fixed manufacturing overhead rateStandard fixed manufacturing overhead rate


Direct Materials Price Standard The direct materials price standard is found by carefully considering: – Expected price increases– Changes in available quantities.– Possible new sources of supply.

Direct Materials Quantity StandardThe direct materials quantity standard is affected by:– Product engineering specifications.– Quality of direct materials.– Age and productivity of machines.– Quality and experience of the work force.


Direct Labor Time Standard The direct labor time standard is based on current

time and motion studies of workers and machines

and past performance.

Direct Labor Rate Standard The direct labor rate standards are affected by

labor union contracts and company personnel

policies.


Standard Direct Materials, Standard Direct Labor Costs Manufacturing Overhead Costs

Standard Direct Materials Cost

= Direct Materials Price Standard X

Direct Materials Quantity Standard

Standard Direct Labor CostStandard Direct Labor Cost

= = Direct Labor Time Standard X Direct Direct Labor Time Standard X Direct

Labor Rate Standard Labor Rate Standard

Standard Manufacturing Overhead Cost

= (Standard Variable Overhead Rate

+Standard Fixed Overhead Rate) X

Application Basis


Standard RatesStandard Variable Manufacturing Overhead Rate

= Total budgeted variable manufacturing overhead costs ÷ Expected number of standard machine hours

Standard Fixed Manufacturing Overhead RateStandard Fixed Manufacturing Overhead Rate= Total budgeted fixed manufacturing overhead= Total budgeted fixed manufacturing overhead

costs ÷Normal capacity in terms of costs ÷Normal capacity in terms of standard standard machine hoursmachine hours


Standard Unit Cost

• A product’s standard unit cost is determined by

adding standard direct materials cost, standard

direct labor cost and standard manufacturing

overhead rate.


Four Step Approach of Variance Analysis

1. Compute the variance. If the variance is

insignificant, actual operating results are close

to or equal to anticipated operation conditions,

no corrective action is needed.

2. Determine the cause of any significant variance.

3. Identify the performance measures that track

those activities.

4. Take action to correct the problem or continue

to improve operations.


Using Variance Analysis to Control Costs

Compute Variance

No CorrectiveAction Needed

NoIs the Variance Material Significant?

Take Corrective Action

Determine Cause(s)of Variance

Yes

Identify and Analyze Performance Measures

to DetermineCorrective Action


Material Variance Analysis The term variance refers to the deviation of the actual

cost from the standard cost due to the various causes.

Variances will occur if in any given production period the actual costs vary from the standard costs.

"Cost variance is the difference between the standard cost and the comparable actual cost incurred during a given period“ : ICMA

For example, if the price paid for material bought during a given production period, differed from the standard (expected) price for that material, a material price variance will arise.

Similarly if the amount of material actually used exceeded the standard (expected) usage a material usage variance will arise.


Material Cost VarianceThe difference between material at the standard material price and actual material price is known as material usage variance. The variance can be favorable or unfavorable .If the actual cost is lower than the standard cost, it is considered as a favorable variance and if the actual cost exceeds the standard cost the difference is deemed to be unfavorable.

• Material Cost Variance (MCV):• = SQSP–AQAP

= (SQ*SP)-(AQ*AP)= ((SQ/SO*AO)*SP)-(AQ*AP)


Material Price Variance (MPV)• Material price variance is the deviation of the

actual price paid from the standard price specified.Formula:

• Material Price Variance (MPV)= AQ (SP–AP)


Possible Causes of Direct Materials Price Variance

• Changes in vendor prices, inaccurate or

outdated direct materials price standards, and

differences between the quality of direct

materials purchased and the quality desired.

• Differences between quantity discounts

received and those anticipated.

• The purchase of substitute direct materials

that differ from product specifications.


Material Usage Variance (MUV)

• It indicates the difference between the standard

quantities of the material specified from the actual

quantity of output and actual quantities of material

used .The material usage variance can be calculated

by multiplying the difference between the actual

quantity and standard quantity by standard price.

Formula:

• Material Usage Variance (MUV) = SP*(SQ-AQ)


Material Mix Variance (MMV)

The material mix variance is the result of the

deviation of the actual composition of a mixture

of the material from the standard one. Normally, a

material mix variance arises where there is the

change in the composition of the material mixture

Formula:

Material Mix Variance (MMV) = (Total Weight of

AM/Total weight of SM)(SC of SM)–SC of AM


Possible causes of a direct materials quantity variance

• Inaccurate or outdated direct materials quantity standards

• Poor workmanship or excellent workmanship

• Faulty equipment

• Inferior or superior quality of direct materials

• Poor materials handling


Material Yield Variance (MYV)• The difference between the standard yield output)

specified and actual yield (output) obtained

• This variance is based on the output of the product

• The standard loss during its processing is expected to

be 15%.

Formula:

Material yield variance (MYV): (Actual yield or output-

Standard yield or output for actual input)*Standard cost

per unit = SC/SO (Actual Yield –standard Yield)


Material Cost Variance (MCV)

Material Price Variance (MPV)

Material Usage Variance (MUV)

Material Mix Variance (MMV)

Material Yield Variance (MYV)

VERIFICATION


Direct Cost Variance (LCV)

Is the difference between the standard direct labor

cost for the actual output and the actual labor cost

paid. The deviation of the actual direct wages paid from

the direct wages specified for the standard output.

Formula: Labour Cost Variance (LCV)

= ST SR – AT A

= ((ST/SO AO)*SR) -(AT AR)


Labor Rate (wage) Variance Difference between standard wage rate per

hour/day/week/month/fixed and actual wage rate paid.

It is usually caused due to increases in wage rate

because of negotiation with the union or other

causes.

Labour Rate Variance = AT (SR – AR)

Causes of Direct Labor Rate Variance

• A worker is hired at a pay rate that is higher or lower

than expected.

• An employee performed the duties of a higher- or

lower-paid position.


Labor Efficiency Variance (LEV)

• “Have the workers performed as efficiently as they were expected to perform”?

• It compares the quantity of work achieved in the time paid for, with the production that should have been achieved in that time if the labor force had worked according to standard timings.

Labour Efficiency Variance (LEV) = SR (ST – AT)

Causes of Direct Labor Efficiency Variance

• Overall wage rates changed due to New labor agreements, labor strikes that cause the temporary hiring of unskilled help, large layouts that result in unusual usage of remaining workers etc.


Favorable Direct Labor Efficiency

Variance A favorable direct labor efficiency variance can be caused by

improved training of employees, new machinery and higher

quality of materials.

Unfavorable Direct Labor Efficiency

VarianceAn unfavorable direct labor efficiency variance can be caused

by machine breakdowns, inferior direct materials, poor

supervision, slow materials handling, and poor employee

performance


Labor Mix Variance (MMV)

It is possible when more than one type of labor

is used for the job.

It represents the variance due to the change in

standard and actual labor force composition.

Labour Mix Variance (LMV) = (Total AT

Mix/Total ST Mix)– SC of AM


Labor Yield Variance (LYV)

It represents that portion of labor efficiency

variance which is due to difference between the

standard output and the actual output.

If the actual labor output is higher as compare

to the relative standard, then variance would be

favorable and vice versa

Labour Yield Variance (LYV)= SR (Actual Yield

or Output – Standard Yield for Actual Input i.e.

Time)


Labor Idle Time Variance (LITV) Sub efficiency variance.

Indicates the standard cost of the actual hours

for which the employees may remain idle due to

abnormal circumstances like strikes, lockouts,

power failure, breakdown of machinery,

unavailability or raw materials etc.

Always unfavorable.

For the accurate of the labor efficiency variance

labor, idle time should be adjusted.

Labour Idle Time Variance = Idle Time SR (U)


Labour Cost Variance (LCV)

Labour Rate Variance (LRV)

Labour Efficiency Variance (LEV)

Labour Mix Variance (LMV)

Labour Yield Variance (LYV)

Labour Idle Time Variance (LITV)

VERIFICATION

(c) ghanendra fago (m. phil, mba) 1 standard costing, variance analysis and management cycle use...

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