Prepared by Debby Bloom-Hill CMA, CFM CHAPTER 11 Standard Costs and Variance Analysis Slide 11-2 Standard Costs and Budgets  Standard cost  Cost that management believes should be incurred to produce a product or service under anticipated conditions  Standard costs can be used by manufacturing and service companies  A tool manufacturer may set a standard cost for producing a hammer  A bank may set a standard cost for processing a check Slide 11-3 Learning objective 1: Explain how standard costs are developed Standard Costs and Budgets  The term standard cost often refers to the cost of a single unit  The term budgeted cost often refers to the cost, at standard, of the total number of budgeted units  The cost information contained in budgets must be consistent with standard costs Slide 11-4 Learning objective 1: Explain how standard costs are developed If materials budget indicates purchases of 5,000 pounds, standard cost is $25,000 (5,000 pounds * $5 standard cost per pound) If labor budget is prepared for 1,000 units produced, 3,000 labor hours are needed at a standard cost of $30,000 (3,000 hours * $10) Slide 11-5 Learning objective 1: Explain how standard costs are developed Starbucks Slide 11-6 Learning objective 1: Explain how standard costs are developed Development of Standard Costs  Standard costs for material, labor and overhead are developed in a variety of ways  Standard quantity and price for material may be specified:  In engineering plans that provide a list of material  In recipes or formulas  By time and motion studies  In price lists provided by suppliers Slide 11-7 Learning objective 1: Explain how standard costs are developed Development of Standard Costs  Standard quantity and rate for direct labor may be specified:  By time and motion studies  Through analysis of past data  By management expectations of rates to be paid  In contracts that set labor rates  Standard costs for overhead involves procedures similar to those used to develop predetermined overhead rates Slide 11-8 Learning objective 1: Explain how standard costs are developed Ideal versus Attainable Standards  In developing standard costs, some managers emphasize ideal standards while others use attainable standards  Ideal standards assumes that no obstacles to the production process will be encountered  Managers who support ideal standards believe they motivate employees to strive for the best possible control over production costs Slide 11-9 Learning objective 1: Explain how standard costs are developed Ideal versus Attainable Standards  Attainable standards are standard costs that take into account the possibility that a variety of circumstances may lead to costs that are greater than ideal  If equipment breakdowns and defects are a fact of life, it makes sense to plan for their associated costs  Most managers support the use of attainable standards Slide 11-10 Learning objective 1: Explain how standard costs are developed Standard for unit: $50 overhead applied Actual overhead: $23,000 to produce 450 units Flexible budget overhead: $15,000 fixed + $20 per unit produced Slide 11-25 Learning objective 3: Calculate and interpret variances for direct labor Interpreting Overhead Volume Variance  Volume variances not signal that overhead costs are in or out of control  A volume variance signals that the quantity of production was greater or less than anticipated  The usefulness of the volume variance is limited  It signals only that more or fewer units have been produced than planned when the standard overhead rate was set Slide 11-26 Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity Standard Cost Variance Formulas Slide 11-27 Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity Standard Cost Variance Formulas Slide 11-28 Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity Test Your Knowledge A favorable labor efficiency variance means: a Labor rates were higher than called for by standards b Inexperienced labor was used, causing the rate to be lower than standard c More labor was used than called for by standards d Less labor was used than called for by standards Answer: d Less labor was used than called for by standards Slide 11-29 Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity Test Your Knowledge What does an unfavorable overhead volume variance mean? a Overhead costs are out of control b Overhead costs are in control c Production was greater than anticipated d Production was less than anticipated Answer: d Production was less than anticipated Slide 11-30 Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity Investigation of Standard Cost Variances  Standard cost variances not provide definitive evidence that costs are out of control and managers are not performing effectively  They should be viewed as an indicator of potential problem areas  The only way to determine whether costs are being effectively controlled is to investigate the facts behind the variances Slide 11-31 Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity Standard Cost Variances Slide 11-32 Learning objective 5: Calculate the financial impact of operating at more or less than planned capacity Management by Exception  Investigation of standard cost variances is a costly activity  A management by exception approach is to investigate only those variances that are considered exceptional  Must determine criteria to measure what is considered exceptional  Absolute dollar value of the variance  The variance as a percent of actual or standard cost Slide 11-33 Learning objective 6: Discuss how the management-by-exception approach is applied to the investigation of standard cost variances “Favorable” Variances May Be Unfavorable  The fact that a variance is favorable does not mean that is should not be investigated  A favorable variance may be indicative of poor management decisions  A poor decision regarding the quality of raw materials might result in an unfavorable variance in material quantity Slide 11-34 Learning objective 7: Explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms of variances may lead to overproduction Can Process Improvements Lead to “Unfavorable” Variances?  A firm may have an unfavorable variance because it engaged in process improvements  They can lead to greater efficiency which results in actual labor hours being less than standard labor hours  Firms should stimulate greater demand to take advantage of the greater production capabilities Slide 11-35 Learning objective 7: Explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms of variances may lead to overproduction Evaluation in Terms of Variances Can Lead to Excess Production  When bottlenecks exist, the department in front of the bottleneck should not produce more than the bottlenecked department can handle  If it does it will create excess work-inprocess inventory and result in a negative impact on shareholder value Slide 11-36 Learning objective 7: Explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms of variances may lead to overproduction Responsibility Accounting and Variances  The central idea of responsibility accounting is that managers should be held responsible for only the costs they can control  Additionally, managers and workers should only be held responsible for variances they can control Slide 11-37 Learning objective 7: Explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms of variances may lead to overproduction Quality Slide 11-38 Learning objective 7: Explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms of variances may lead to overproduction Copyright © 2010 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Slide 11-39