CHAPTER 24 Standard Costing and Variance Analysis Principles of Accounting 12e Needles Powers Crosson ©human/iStockphoto Concepts Underlying Standard Costing S tandard c o s ts are realistic estimates of costs based on analyses of both past and projected operating costs and conditions S tandard c o s ting is a method of cost control that is used to compare the difference, or varianc e , between standard and actual performance – This method differs from actual and normal costing methods in that it uses estimated costs exclusively to compute all three elements of product cost – Managers find standard costing and variance analysis useful to develop budgets, to control costs, and to prepare reports – A disadvantage to using standard costing is that it can be expensive and time-consuming to gather all the needed information ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Variance Analysis and Computing Standard Costs Varianc e analys is is the process of computing the differences between standard costs and actual costs and identifying the causes of those differences – A fully integrated standard costing system uses standard costs for all the elements of product cost Standard costs are recorded in inventory accounts for materials, work in process, and finished goods, as well as Cost of Goods Sold Actual costs are recorded separately so that managers can compare what should have been spent (the standard costs) with the actual costs incurred in the cost center A standard unit cost for a manufactured product has the following six elements: direct materials price standard; direct materials quantity standard; direct labor time standard; direct labor rate standard; variable overhead rate standard; and fixed overhead rate standard ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Standard Direct Materials Cost The s tandard dire c t mate rials c o s t is the price that should be paid for the materials and is computed as follows – In this equation, the dire c t mate rials pric e s tandard is a careful estimate of the cost of a specific direct material in the next period – The dire c t mate rials quantity s tandard is an estimate of the amount of direct materials, including scrap and waste, that will be used in a period ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Standard Direct Labor Cost The s tandard dire c t labo r c o s t is the cost necessary to produce a product, task, or job order and is computed as follows – The dire c t labo r rate s tandard is the hourly direct labor rate that is expected to prevail during the next period for each function or job classification – The dire c t labo r time s tandard is the expected labor time required for each department, machine, or process to complete the production of one unit or one batch ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Standard Overhead Cost The s tandard o ve rhe ad c o s t is the sum of the estimates of variable and fixed overhead costs in the next period It has two parts: variable costs and fixed costs – The s tandard variable o ve rhe ad rate is computed by dividing the total budgeted variable overhead costs by an expression of capacity, such as the budgeted number of standard machine hours or standard direct labor hours, as shown in the formula below: – The s tandard fixe d o ve rhe ad rate is computed by dividing the total budgeted fixed overhead costs by an expression of capacity, usually normal capacity in terms of standard hours or units ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part The Role of Flexible Budgets in Variance Analysis The accuracy of variance analysis depends to a large extent on the type of budget that managers use when comparing variances – Static, or fixed, budgets forecast revenues and expenses for just one level of output ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Using Variance Analysis to Control Costs Using variance analysis to control costs is a four-step process ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Computing and Analyzing Direct Materials Variances To control cost center operations, managers compute and analyze variances for whole cost categories, such as total direct materials costs, as well as variances for elements of those categories, such as the price and quantity of each direct material ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Computing and Analyzing Direct Materials Variances To find the area responsible for the variance, the total direct materials cost variance must be broken down into the direct materials price variance and the direct materials quantity variance ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Computing Total Direct Labor Cost Variance For effective performance evaluation, management must know how much of the total cost arose from different direct labor rates and how much from different numbers of direct labor hours, which is found by computing the direct labor rate variance and the direct labor efficiency variance ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Computing Variable Overhead Spending and Variable Overhead Efficiency Variances Managers must know how much of the total cost arose from variable overhead spending deviations and how much from variable overhead application deviations ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Total Fixed Overhead Cost Variance For effective performance evaluation, managers break down the total fixed overhead cost variance into two additional variances: the fixed overhead budget variance and the fixed overhead volume variance ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Variance Analysis and the Management Process Manager responsibilities for standard costing and variance analysis within the management process of planning, performing, evaluating, and reporting on cost center operations are: Plan Perform Evaluate Communicate ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Using Cost Variances to Evaluate Managers’ Performance Variance analysis is usually more effective at pinpointing efficient and inefficient operating areas than are basic comparisons of budgeted and actual data – A managerial performance report based on standard costs and related variances should identify the causes of each significant variance, the personnel involved, and the corrective actions taken – The mere occurrence of a variance does not indicate that a manager has performed poorly, so long as causes are identified and corrective action is taken ©2014 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part ... tandard is a careful estimate of the cost of a specific direct material in the next period – The dire c t mate rials quantity s tandard is an estimate of the amount of direct materials, including... tandard fixe d o ve rhe ad rate is computed by dividing the total budgeted fixed overhead costs by an expression of capacity, usually normal capacity in terms of standard hours or units ©2014 Cengage... the sum of the estimates of variable and fixed overhead costs in the next period It has two parts: variable costs and fixed costs – The s tandard variable o ve rhe ad rate is computed by dividing