managerial accounting, chapter 9 by crosson, needles
TRANSCRIPT
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Chapter 9
Standard Costingand Variance Analysis
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Standard Costing
Objective 1– Define standard costs, and describe how
managers use these costs.
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Standard Costing
A method of cost control that includes a measure of actual
performance and a measure of the difference, or variance, between standard and actual
performance
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Standard Costs
• Provide a predetermined performance level for the standard costing method
• Usually stated in terms of cost per unit
Realistic estimates of costs based on analysis of both past and projected
operating costs and conditions
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What Are Standard Costs Based On?
• Past costs• Engineering estimates• Forecasted demand• Worker input• Time and motion studies• Type and quality of direct
materials
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Standard Costing versus Normal and Actual Costing
Product Cost Elements
Standard Costing
Normal Costing
Actual Costing
Direct Materials Estimated costs Actual costs Actual costs Direct Labor Estimated costs Actual costs Actual costs Overhead Estimated costs Estimated costs Actual costs
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Standard Costs and Managers
– Managers use standard costs to develop budgets and establish goals for product costing
• Direct materials
• Direct labor
• Variable overhead
Planning
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Standard Costs and Managers (cont’d)
Performing – Managers use standard costs to apply
dollar, time, and quality standards to work
– Actual cost data are collected
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Evaluating – Managers compare standard and
actual costs – Compute variances– Variances provide measures of
performance that can be used to control costs and evaluate managers
• Analyze significant variances to reveal operating problems of the cost center or to indicate favorable practices
Standard Costs and Managers (cont’d)
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Communicating – Managers use standard costs to report
on operations in cost centers and on the performance of managers in various cost centers
Standard Costs and Managers (cont’d)
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The Relevance of Standard Costing
in Today's Business Environment• Increased
automation has caused a significant decrease in direct labor costs
• Many companies now apply standard costing only to direct materials and overhead
In manufacturing: In service organizations:
• Use standard costing for labor and overhead costs
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Stop & Review
Q. What is the main difference between the standard costing and normal costing methods?
A. The standard costing method uses estimated costs for direct materials and direct labor, whereas the normal costing method uses actual costs for these items. The methods are similar in that both use estimated costs for overhead.
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Computing Standard Costs
Objective 2– Explain how standard costs are developed
and compute a standard unit cost.
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Computing Standard Costs
– Inventory accounts and the Cost of Goods Sold account are maintained and reported in terms of standard costs
– Standard unit costs used to compute account balances
– Actual costs recorded separately
– Actual and standard costs can then be compared
Fully integrated standard costing system uses standard costs for all elements of product cost
•Direct materials •Direct labor •Overhead
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Elements of a Standard Unit Cost
1. Price standard for direct materials
2. Quantity standard for direct materials
3. Standard for direct labor rate
4. Standard for direct labor time
5. Standard for variable overhead rate
6. Standard for fixed overhead rate
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Standard Direct Materials Cost
Multiply the price standard for direct materials by the quantity standard for direct materials
Standard Direct Materials Cost
= Direct Materials Price Standard
x Direct Materials
Quantity Standard
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Direct Materials Price Standard
• Takes into account– All possible price increases– Changes in available
quantities– New sources of supply
Developed by the purchasing
agent or purchasing department
Is a careful estimate of the cost of a specific direct material in the next accounting period
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Direct Materials Quantity Standard
Is an estimate of the amount of direct materials that will be used in the accounting period
(includes scrap and waste)
– The estimate is influenced by: • Product engineering specifications• Quality of direct materials• Age and productivity of machinery• Quality and experience of work force
– Established and monitored by: • Production managers• Management accountants• Others (engineers, purchasing agents, machine operators)
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Standard Direct Labor Cost
Calculated by multiplying the standard wage for direct labor by the standard hours of direct labor for a product, task, or job
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Direct Labor Rate Standard
• Hourly direct labor rate expected to prevail during the next accounting period– For each function or job classification
• Average standard rate is developed for each task– Standard rate is used even if worker is paid
more or less than the standard rate
• Easy to establish• Rates are set by labor unions or defined by the
company
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Direct Labor Time Standard
• Expected time required for each department, machine, or process to complete the production of one unit or one batch of output
• Developed using– Current time and motion studies of workers and
machines
– Records of past performance
• Should be revised when– Machinery is replaced
– Quality of labor force changes
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Standard Overhead Cost
Variable Costs Fixed Costs
The sum of the estimates of variable and fixed overhead costs in the next accounting
period
Compute separately because their cost behavior differs
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Standard Variable Overhead Rate
Computed by dividing the total budgeted variable overhead costs by an expression of capacity, such as number of standard direct
labor hours or standard machine hours
Total Budgeted Variable Overhead Costs Standard Variable Overhead Rate
= Expected Number of Standard Machine Hours
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Standard Fixed Overhead Rate
Computed by dividing the total budgeted fixed overhead costs by an expression of
capacity, usually normal capacity in terms of standard hours or units
Total Budgeted Fixed Overhead Costs Standard Fixed Overhead Rate
= Normal Capacity in Terms of Standard Machine Hours
Normal capacity is the level of operating capacity needed to meet expected sales demand
Its use ensures that all fixed OH* costs have been applied to units produced by
the time normal capacity is reached
*Overhead
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Total Standard Unit Cost Illustrated
Remember When, Inc., recently updated the standards for its line of watches
Direct materials price standards Casing materials $9.20 per square foot Movement mechanism $2.17 each Direct materials quantity standards Casing materials .025 square foot per watch Movement mechanism 1 per watch Direct labor time standards Case Stamping Department .01 hour per watch Watch Assembly Department .05 hour per watch Direct labor rate standards Case Stamping Department $8.00 per hour Watch Assembly Department $10.20 per hour Standard manufacturing overhead rates Standard variable overhead rate $12.00 per direct labor hour Standard fixed overhead rate $9.00 per direct labor hour
Compute the total standard cost of one watch
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Stop & Review
Q. Why are the variable and fixed components for the standard overhead cost computed separately?
A. Variable costs and fixed costs are computed separately because their cost behavior differs.
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Variance Analysis
Objective 3– Prepare a flexible budget, and describe
how managers use variance analysis to control costs.
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Variance Analysis
The process of computing the differences between standard costs and actual costs and identifying the causes of those differences
Accuracy of variance analysis depends on the kind of budget used•Static Budget •Flexible Budget
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Static Budgets
• Also called fixed budgets
• Do not allow for changes in output level
• If actual output differs from budgeted output, a variance between actual and budgeted amounts will occur
• Cannot judge performance accurately
Forecast revenues and expenses for just one level of sales and one level of output
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Performance Report Using Data from a Static Budget
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Flexible Budgets
Summary of expected costs for a range of activity levels
• Also called variable budgets• Provide forecasted data that can be
adjusted for changes in output level• Used primarily as a cost control tool in
evaluating performance
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Flexible Budget Formula
An equation that determines the expected, or budgeted, cost for any level of output• Includes:
– Per unit amount for variable costs
– Total amount for fixed costs
Costs Fixed Budgeted Produced) Unitsof No. per Unit Cost (Variable Costs Budgeted Total
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Flexible Budget for Evaluation of Overall Performance
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Flexible Budget Formula Illustrated
Remember When, Inc.:
$9,450 Produced) Unitsof No. ($3.71 Costs Budgeted Total
$9,450 19,100) ($3.71 Costs Budgeted Total $9,450 $70,861
$80,311
The company produced 19,100 units:
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Performance Report Using Data from a Flexible Budget
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Is the variance significant?
Using Variance Analysis to Control Costs
Compute variance
No corrective action needed
No
Yes
Analyze variance todetermine its cause
Select performance measures to correct
the problem
Take corrective action
Step 1
Step 2
Step 3
Step 4
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Using Variance Analysis to Control Costs (cont’d)
– But, this does not prevent the variance from happening again
– Must determine the cause:• Select performance measures that will help track the
problem
• Must then find the best solution
Computing variances are important
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Stop & Review
Q. What is the flexible budget formula?
per Unit Cost (Variable Costs Budgeted Total
Produced) Unitsof No.
Costs Fixed Budgeted
A. It is an equation used to determine expected, or budgeted costs for any level of output.
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Computing and Analyzing Direct Materials Variances
Objective 4– Compute and analyze direct materials
variances.
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Why Compute and Analyze Variances?
• To control whole cost categories – Such as total direct materials costs
• To control elements of those categories– Such as the price and quantity of each direct
material
The more detailed the analysis of a variance is, the more effective managers
will be in controlling costs
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Computing Direct Materials Variances
Total direct materials cost variance is the difference between the standard cost and actual
cost of direct materials
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Direct Materials Variances Illustrated
Cambria Company makes leather bags. Each bag should use 4 feet of leather (standard quantity), and the standard price of leather is $6.00 per foot. During August, the company purchased 760 feet of leather costing $5.90 per foot and used the leather to produce 180 bags.
cost Standard
bag)per feet 4 bags (180foot per $6.00$4,320 720foot per $6.00
cost actual Less
4,484 760foot per $5.90
quantity standard price Standard
quantity actual price Actual
ncecost varia materialsdirect Total (U) 164 $
Actual cost > standard cost
This is an unfavorable (U) situation
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Direct Materials Variances
• Total direct materials cost variance must be broken into two parts to find the cause of the variance– Direct materials price variance– Direct materials quantity variance
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Computing Direct Materials Variances
Direct materials price variance– Difference between the standard price and the
actual price per unit multiplied by the actual quantity purchased
– Also called the direct materials spending or rate variance
Price) Actual Price (Standard Variance Price MaterialsDirect Quantity Actual
feet 760 $5.90) ($6.00
Because the company paid less for direct materials than it expected, the variance is favorable (F)
(F) $76
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Computing Direct Materials Variances (cont’d)
Direct materials quantity variance– Difference between the standard quantity allowed and
the actual quantity used multiplied by the standard price
– Also called the direct materials efficiency or usage variance
Quantity (Standard Price Standard VarianceQuantity MaterialsDirect Quantity) Actual Allowed
feet) 760 feet (720 $6.00
Because the company used more for direct materials than it expected, the variance is unfavorable (U)
(U) $240
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Test Calculations of Variances
• If correct, the net of the direct materials price variance and direct materials quantity variance will equal the total direct materials cost variance
Direct materials price variance $ 76 (F) Direct materials quantity variance 240 (U) Total direct materials cost variance $164 (U)
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Diagram of Direct Materials Variance Analysis
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Analyzing and Correcting Direct Materials Variances
Company had experienced direct materials price and quantity variances for some time
Managers tracked purchasing activities•Discovered that the purchasing agent had purchased, without authorization, a lower grade of leather at a reduced price •After analysis, engineers determined the lower grade leather was not appropriate
Discovered that inferior leather was causing the unfavorable quantity variance
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Stop & Review
Q. What is the direct materials price variance?
Price) Actual Price (Standard Variance Price MaterialsDirect Quantity Actual
A. It is the difference between the standard price and the actual price per unit multiplied by the actual quantity purchased. It is also called the direct materials spending or rate variance.
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Computing and Analyzing Direct Labor Variances
Objective 5– Compute and analyze direct labor variances.
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Computing Direct Labor Variances
Total direct labor cost variance is the difference between the standard direct labor cost for good
units produced and actual direct labor costs
Good units are the total units produced less units that are scrapped or need to be
reworked
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Direct Labor Variances IllustratedAt Cambria Company, each leather bag requires 2.4 standard direct labor hours, and the standard direct labor rate is $8.50 per hour. During August, 450 direct labor hours were used to make 180 bags at an average pay rate of $9.20 per hour.
cost Standard
bag)per hours 2.4 bags (180 $8.50
$3,672 hours 432 $8.50 cost actual Less
4,140 hours 450 $9.20
allowed hours standard rate Standard
hours actual rate Actual
ncecost varialabor direct Total (U) 468 $
Actual cost > standard cost
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Direct Labor Variances
Total direct labor cost variance must be broken into two parts to find the cause of
the variance
•Direct labor rate variance•Direct labor efficiency variance
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Direct Labor Rate Variance
– Difference between the standard direct labor rate and the actual direct labor rate multiplied by the actual direct labor hours worked
– Also called the direct labor spending variance
Hours Actual x Rate) Actual Rate (Standard Variance RateLabor Direct
hours 450 $9.20) ($8.50
(U) $315
Because the company paid more per hour for direct labor than it expected, the variance is
unfavorable
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Direct Labor Efficiency Variance
– Difference between the standard direct labor hours allowed for good units produced and the actual direct labor hours worked multiplied by the standard direct labor rate
– Also called the direct labor quantity or usage variance
hours) 450 hours (432 $8.50
(U) $153 Because the company used more direct labor hours than it
expected, the variance is unfavorable (U)
Allowed Hours (Standard Rate Standard Variance EfficiencyLabor Direct Hours) Actual -
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Test Calculations of Variances
• If correct, the net of the direct labor rate variance and direct labor efficiency variance will equal the total direct labor cost variance
Direct labor rate variance $ 315 (U) Direct labor efficiency variance 153 (U) Total direct labor cost variance $468 (U)
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Diagram of Direct Labor Variance Analysis
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Analyzing and Correcting Direct Labor Variances
Materials handling– Parts delivered late on five occasions
• Will track delivery time and number of delays for next three months
Employee time cardsAn assembly worker who had fallen ill was replaced with a machinery operator from another department
Assembly worker is paid $8.50 per hour and the machine operator is paid $9.20 per hourMachine operator not as skilled as the assembly worker
Temporary situation so no corrective action taken
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Stop & Review
Q. What is the direct labor efficiency variance?
Hours (Standard Rate Standard Variance EfficiencyLabor Direct Hours) Actual Allowed
A. The direct labor efficiency variance is the difference between the standard direct labor hours allowed for good units produced and the actual direct labor hours worked multiplied by the standard direct labor rate. It is also called the direct labor quantity or usage variance.
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Computing and Analyzing Overhead VariancesObjective 6
– Compute and analyze overhead variances.
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Computing and Analyzing Overhead Variances
– Responsibility for overhead costs is hard to assign
• Fixed overhead costs– Unavoidable past costs
– Not under the control of any department manager
• Variable overhead costs– Some control possible if they can be related to
departments or activities
Controlling variable and fixed overhead costs is more difficult for managers than controlling direct
materials and direct labor costs
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Using a Flexible Budget to Analyze Overhead Variances
– For overhead costs only– Evaluate activity level using direct labor hours
• Variable costs vary with the number of direct labor hours worked
• Total fixed overhead costs remain constant
• Cambria Company’s managers use a flexible budget to evaluate performance
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Flexible Budget for
Evaluation of Overhead
Costs
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Using a Flexible Budget to Analyze Overhead Variances
• Flexible budget formula when applied to Cambria’s data:
Hour Labor Direct per Costs (Variable Costs OH Budgeted Total
Hours)Labor Direct ofNumber
Costs OH Fixed Budgeted
Hours)Labor Direct of No. ($5.75 Costs OH Budgeted Total
$1,300
To find the total monthly budgeted overhead costs, insert direct labor hours into the flexible budget
• Flexible budget formula:
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Computing Overhead Variances
– Standard overhead costs are applied to production using a standard overhead rate
• Standard overhead rate has two parts– Variable rate
– Fixed rate
Difference between actual overhead costs and standard overhead costs applied
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Computing Overhead Variances (cont’d)
For Cambria Company, the standard variable overhead rate is $5.75 per direct labor hour (from the flexible budget). The standard fixed overhead rate is found by dividing total budgeted fixed overhead ($1,300) by normal capacity, which is 400 direct labor hours.
rate overhead Fixed
$3.25 hourslabor direct 400 $1,300
rate overhead standard Total
$9.00 $3.25 $5.75
capacity normal overhead fixed Budgeted
rate overhead fixed standard rate overhead variableStandard
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888,3$ bag)per hours 2.4 bags (180hour labor direct per $9.00 costs overhead actual Less
varianceoverhead Total (U) 212 $
produced units good No.( rate OH standard Total allowed) hours standard
4,100
produced units good toapplied costs OH Standard
This amount can be divided into variable overhead variances and fixed overhead variances
Actual cost > standard cost
For Cambria Company, the standard variable overhead rate is $5.75 per direct labor hour (from the flexible budget). The standard fixed overhead rate is found by dividing total budgeted fixed overhead ($1,300) by normal capacity, which is 400 direct labor hours.
Computing Overhead Variances (cont’d)
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Variable Overhead Variances
The total variable overhead variance is the difference between actual variable overhead costs and the standard
variable overhead costs that are applied to good units produced using the standard variable rate
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Variable Overhead Variances (cont’d)
At Cambria Company, each leather bag requires 2.4 standard direct labor hours and the standard variable overhead rate is $5.75 per direct labor hour. During August, the company incurred $2,500 of variable overhead costs.
Actual cost > standard cost
bag)per hours 2.4 bags (180hour per $5.75
cost actual Less
produced units good toapplied Overhead
ncecost varia overhead variableTotal (U) 16 $
allowed hourslabor direct standard rate variableStandard
2,500$2,484 hours 432 $5.75
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Diagram of Variable Overhead Variance Analysis
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Total variable overhead cost variance must be broken into two parts to find the
cause of the variance– Variable overhead spending variance– Variable overhead efficiency variance
Variable Overhead Variances (cont’d)
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Variable Overhead Spending VarianceDifference between the budgeted variable overhead costs
at actual hours and actual variable overhead; also called the variable overhead rate variance
Actual Rate Variable (Standard OH Variable Actual Worked)Hours
$2,500 hours) 450 ($5.75 (F) $87.50
Hours Actualat Costs Variable Budgeted Variance Spending OH Variable Overhead Variable Actual
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Variable Overhead Efficiency Variance
Difference between the standard direct labor hours allowed for good units produced and the actual hours worked multiplied by the standard
variable overhead rate
(Standard Rate Variable Standard Variance Efficiency OH Variable
Hours) Actual Allowed Hours
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Compute variable overhead efficiency variance
Variable Overhead Variances
hours) 450 hours (432 $5.75
Bagper Hours Standard Produced UnitsGood Allowed Hours Standard bagper hours 2.4 bags 180
hours 432
(U) 50.103$
(Standard Rate Variable Standard Variance Efficiency OH Variable
Hours) Actual Allowed Hours
Compute standard hours allowed
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Test Calculations of Variances
• If correct, the net of the variable overhead spending variance and variable overhead efficiency variance will equal the total variable overhead cost variance
Variable overhead spending variance $ 87.50 (F) Variable overhead efficiency variance 103.50 (U) Total variable overhead cost variance $ 16.00 (U)
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Fixed Overhead Variances
Difference between actual fixed overhead costs and the standard fixed overhead costs that are
applied to good units produced using the standard fixed overhead rate
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Diagram of Fixed
Overhead Variance Analysis
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Fixed OverheadVariances Illustrated
At Cambria Company, each leather bag requires 2.4 standard direct labor hours and the standard fixed overhead rate is $3.25 per direct labor hour. During August, the company incurred $1,600 of actual fixed overhead costs.
bag)per hours 2.4 bags (180hour per $3.25
produced units good toapplied Overhead
ncecost varia overhead fixed Total (U) 196 $
allowed hourslabor direct standard rate fixed Standard
cost actual Less 1,600$1,404 hours 432 $3.25
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Analyze Two Parts
Total fixed overhead cost variance must be broken into two parts to find the cause of the variance– Fixed overhead budget variance– Fixed overhead volume variance
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Fixed Overhead Budget Variance
• Difference between the budgeted and actual fixed overhead costs
• Also called budgeted fixed overhead variance
Overhead Fixed Budgeted VarianceBudget OH Fixed
Overhead Fixed Actual
$1,600 $1,300
(U) $300
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Fixed Overhead Volume Variance
Difference between budgeted fixed overhead costs and overhead costs applied to production
using the standard fixed overhead rate
produced units good toapplied OH fixed Standard
bag)per hours 2.4 bags (180 hour labor direct per $3.25 $1,404overhead fixed budgeted totalLess 1,300
variance volumeoverhead Fixed (F) 104 $
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Fixed Overhead Variances
– Fixed overhead volume variance measures the use of existing facilities and capacity
– Favorable overhead volume variance• Capacity exceeds the expected amount
– Unfavorable overhead volume variance• Company operates at a level below normal capacity
– May be in best interest of company during periods of slow sales
– Means company is not building up excess inventory
• A volume variance will occur if more or less than normal capacity is used
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Summary of Overhead Variances
Variable overhead spending variance $ 87.50 (F) Variable overhead efficiency variance 103.50 (U) Fixed overhead budget variance 300.00 (U) Fixed overhead volume variance 104.00 (F) Total overhead variance $212.00 (U)
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Analyzing and Correcting Overhead Variances
Variance Amount Cause Corrective Action Variable overhead spending variance
$87.50 (F) Savings on purchases No action
Variable overhead efficiency variance
103.50 (U) Inefficiency of machine operator who substituted for ill assembly worker
Consider feasibility of implementing a program for cross-training employees
Fixed overhead budget variance
300.00 (U)
Higher than expected factory insurance premiums due to increased claims filed by employees
Study insurance claims filed over a three-month period
Fixed overhead volume variance
104.00 (F) Overutilization of capacity traced to high seasonal demand
No action necessary because variance fell within anticipated range
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Stop & Review
Q. What four variances are used to analyze the total overhead variance?
A. Variable overhead spending variance Variable overhead efficiency variance
Fixed overhead budget variance
Fixed overhead volume variance
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Using Cost Variances to Evaluate Managers’ Performance
Objective 7– Explain how variances are used to evaluate
managers’ performance.
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Factors in Fairness of Performance Evaluation
• Human factors
• Company policies– Should be based on input from managers
and employees– Should specify procedures that managers
are to use
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Procedures to Specify for Managers
• Preparing operational plans• Assigning responsibility for carrying out the
operational plans• Communicating operational plans to key
personnel• Evaluating performance in each area of
responsibility• Identifying causes of significant variances from
the operational plan• Taking corrective action to eliminate problems
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Variance Analysis
• Provides detailed data about differences between standard and actual costs– Effective at pinpointing efficient and
inefficient operating areas• Basic comparison of budgeted and actual data
not as effective
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Using Cost Variances to Evaluate Managers’ Performance (cont’d)
– Identify causes of the differences, personnel involved, corrective actions taken
– Be tailored to the manager’s specific areas of responsibility
Managers should only be held accountable for cost areas under their control
• Effective managerial performance reports based on standard costs and related variances should
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Managerial Performance Reports
• Summarize all cost data
• Include variances for direct materials, direct labor, and overhead
• Identify– Causes of variances– Corrective actions taken
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Stop & Review
Q. What items should be included in an effective managerial performance report?
A. Summarization of all cost dataVariances for direct materials, direct labor, and overhead
Identification of the causes of the variances, personnel involved, and any corrective actions taken
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Chapter Review
1. Define standard costs, and describe how managers use these costs.
2. Explain how standard costs are developed, and compute a standard unit cost.
3. Prepare a flexible budget, and describe how managers use variance analysis to control costs.
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Chapter Review (cont’d)
4. Compute and analyze direct materials variances.
5. Compute and analyze direct labor variances.
6. Compute and analyze overhead variances.
7. Explain how variances are used to evaluate managers’ performance.