CHAPTER CHAPTER 11 11 Standard Costs and Variance Analysis Slide 11-2 Standard Standard Costs Costs and and Budgets 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 Learning objective 1: Explain how standard costs are developed, and calculate and interpret Slide 11-3 variances for direct material and direct labor Standard Standard Costs Costs and and Budgets 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 Learning objective 1: Explain how standard costs are developed, and calculate and interpret Slide 11-4 variances for direct material and direct labor Standard Standard Costs Costs and and Budgets Budgets If the materials budget indicates purchases of 5,000 pounds, standard cost is $25,000 (5,000 pounds * $5 standard cost per pound) If the 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) Learning objective 1: Explain how standard costs are developed, and calculate and interpret Slide 11-5 variances for direct material and direct labor Starbucks Starbucks Learning objective 1: Explain how standard costs are developed, and calculate and interpret Slide 11-6 variances for direct material and direct labor Development Development of of Standard Standard Costs 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 Learning objective 1: Explain how standard costs are developed, and calculate and interpret Slide 11-7 variances for direct material and direct labor Development Development of of Standard Standard Costs 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 Learning objective 1: Explain how standard costs are developed, and calculate and interpret Slide 11-8 variances for direct material and direct labor Ideal Ideal versus versus Attainable Attainable Standards 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 Learning objective 1: Explain how standard costs are developed, and calculate and interpret Slide 11-9 variances for direct material and direct labor Ideal Ideal versus versus Attainable Attainable Standards 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 Learning objective 1: Explain how standard costs are developed, and calculate and interpret Slide 11-10 variances for direct material and direct labor Overhead Overhead Variances Variances Standard for unit: $50 overhead applied Actual overhead: $23,000 to produce 450 units Flexible budget overhead: $15,000 fixed + $20 per unit produced Learning objective 2: Calculate and interpret variances for manufacturing overhead, and calculate Slide 11-25 the financial impact of operating at more or less than planned capacity Interpreting Interpreting Overhead Overhead Volume Volume Variance 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 Learning objective 2: Calculate and interpret variances for manufacturing overhead, and calculate Slide 11-26 the financial impact of operating at more or less than planned capacity Standard Standard Cost Cost Variance Variance Formulas Formulas Learning objective 2: Calculate and interpret variances for manufacturing overhead, and calculate Slide 11-27 the financial impact of operating at more or less than planned capacity Standard Standard Cost Cost Variance Variance Formulas Formulas Learning objective 2: Calculate and interpret variances for manufacturing overhead, and calculate Slide 11-28 the financial impact of operating at more or less than planned capacity Test Your Knowledge A favorable labor efficiency variance means: a b c d Labor rates were higher than called for by standards Inexperienced labor was used, causing the rate to be lower than standard More labor was used than called for by standards Less labor was used than called for by standards Answer: d Less labor was used than called for by standards Learning objective 2: Calculate and interpret variances for manufacturing overhead, and calculate Slide 11-29 the financial impact of operating at more or less than planned capacity Test Your Knowledge What does an unfavorable overhead volume variance mean? a b c d Overhead costs are out of control Overhead costs are in control Production was greater than anticipated Production was less than anticipated Answer: d Production was less than anticipated Learning objective 2: Calculate and interpret variances for manufacturing overhead, and calculate Slide 11-30 the financial impact of operating at more or less than planned capacity Investigation Investigation of of Standard Standard Cost Cost Variances 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 Learning objective 3: Discuss how the management-by-exception approach is applied to the investigation of standard cost variances Also, explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms Slide 11-31 of variances may lead to overproduction Standard Standard Cost Cost Variances Variances Learning objective 3: Discuss how the management-by-exception approach is applied to the investigation of standard cost variances Also, explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms Slide 11-32 of variances may lead to overproduction Management Management by by Exception 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 Learning objective 3: Discuss how the management-by-exception approach is applied to the investigation of standard cost variances Also, explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms Slide 11-33 of variances may lead to overproduction “Favorable” “Favorable” Variances Variances May May Be Be Unfavorable 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 Learning objective 3: Discuss how the management-by-exception approach is applied to the investigation of standard cost variances Also, explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms Slide 11-34 of variances may lead to overproduction Can Can Process Process Improvements Improvements Lead Lead to to “Unfavorable” “Unfavorable” Variances? 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 Learning objective 3: Discuss how the management-by-exception approach is applied to the investigation of standard cost variances Also, explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms Slide 11-35 of variances may lead to overproduction Evaluation Evaluation in in Terms Terms of of Variances Variances Can Can Lead Lead to to Excess Excess Production 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-in-process inventory and result in a negative impact on shareholder value Learning objective 3: Discuss how the management-by-exception approach is applied to the investigation of standard cost variances Also, explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms Slide 11-36 of variances may lead to overproduction Responsibility Responsibility Accounting Accounting and and Variances 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 Learning objective 3: Discuss how the management-by-exception approach is applied to the investigation of standard cost variances Also, explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms Slide 11-37 of variances may lead to overproduction Quality Quality Learning objective 3: Discuss how the management-by-exception approach is applied to the investigation of standard cost variances Also, explain why a favorable variance may be unfavorable, how process improvements may lead to unfavorable variances, and why evaluation in terms Slide 11-38 of variances may lead to overproduction Copyright Copyright © 2016 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 .. .CHAPTER CHAPTER 11 11 Standard Costs and Variance Analysis Slide 11- 2 Standard Standard Costs Costs and and Budgets Budgets Standard... Slide 11- 11 variances for direct material and direct labor Standard Standard Costing Costing Learning objective 1: Explain how standard costs are developed, and calculate and interpret Slide 11- 12... interpret Slide 11- 5 variances for direct material and direct labor Starbucks Starbucks Learning objective 1: Explain how standard costs are developed, and calculate and interpret Slide 11- 6 variances