a — Chapter 20 Standard Costing Introduction Acompany can employ a cost accounting system that records manufacturing related activity using actual costs (actual or normal costing system) or standard costs (standard cost system). ina standard cost system, management, using information form historical data, inputs from factory employees and supervisory personnel, and data relevant to the industry ond the technology that relates to the manufacturing process, will determine the amount that the manufacturing activity should cost and compares this to the amount that it octually costs. Although external financial statements under a standard cost system are not generally acceptable, the use of standard costing is a means of allowing management tc evaluate the performance of the manufacturing related departments on a management by exception basis. Under the concept of management by exception, material differences between expected performance and actual performance are investigated, whether fovorable or unfavorable. If differences, referred to as variances, are not material, management will ignore them under the assumption that things proceed smoothly as expected. Selecting Standards There are several factors that must be considered in standards setting including economic Conditions, the efficiency or inefficiency of the production process, availability of qualified laborers, and quality materials. There are also different methods for such selection: * Standards based upon past performance are not widely used. The major reason is that inefficiencies of previous periods sill exist. It also neglects Changes in economic Conditions and other factors from one period to the next. . Basic Standards are standards that are developed when the standard cost system is inifiated, but do not change any time in the future. These are not realistic. and over long periods of time become somewhat meaningless 7 + Perfection or Maximum or Ideal Standards are based yj Wherein allowances are not considered. They are unreal productive. pon perfect conditions istic and often counter- 10051006 Mu, Chapter 20 use. They are usually Maintain ther, but tox facturing th e ones most commonly t substantial effort to maint 2. Currently Atlainable Standards are the ‘d by a reasonably efficient man strict enough so that it will require s enough so that they can be achieve system, Advantages ‘and gaining insights i tions nd controlling opera sian oe ore ren oeracad al decisions ‘on costs and profits. Stand: into the probable impact of managerial ‘are used for: 1, Establishing budgets 2. Cost control 3. Price setting . 4. Cost awareness Direct Materials Direct materials variances are usually divided into price and usage/efficiency components. Part of a total materials variance may be attributed to using more raw materials thon the standard quantity and part to a cost that was higher than standard. These two sources of the total variance can be isolated as follows: A. Materials Price Variance is the actual price less the standard price, times the actual quantity: (Actual Price - Standard Price) x Actual Quantity * The price variance may be isolated at the time of purchase or when the materials are issued to production (materials are transferred). * Analysis of variance - if the variance is favorable, it indicates the company has spent less money than expected; however, this may not benefit the company. If less money was spent, but a lesser quality of material was purchased, the quality of the finished product may not be good and sales may decline. If the quality was the same, however, then, this favorable variance benefited the company. If an unfavorable variance resulted, management must determine whether the purchasing department is not functioning properly, or if the standard price is unreasonable. + Responsibility itis usually the purchasing department that is responsible for materials price variance. 5 8. Materials Quantity (or Efficiency) Varlance is the actual quantity less the standord quantity, times the standard price. (Actual Quantity Used St i Standard Price. landard Quantity) x * When determining the materials quantity variance, the a: Meet . ctual he materials is ignored because the only concem is the amount Suvaenes that would have occurred given no price variance. + Analysis of variance ~ if the variance is favorable it indi hove ellher been unusually efficient or are producing inne’ Sea a with less than the standard quantity of materials. Hence, a Yevorable voriance is not always positive. A favorable may be os badcx or worcwron an unfavorable variance, it may suggest that costs have been redused at the expense of product quality.1007 a ed by waste, MAnLeverable materials quantity variance is uSUAlY, COnty wherein the Or ee Or Nett. Possibly materia’ ore being used inet"icle ight need further: training. 1 ost center tha ion department OF ECE onsiple. joduction process is fesP ity ~ as a result : , the produc e direct materials into the pr journal Entries for Direct Materlals controls the 1, Materials are recorded at standard Price: a. To record purchase of materials: Materials at standard price Accounts payable, at actual price Materials Purchase Price variance-fav, KKK XxX XXX b. To record the issuance of materials to production: Work in Process, at standard cost . Materials Quantity Variance - unfavorable..... Materials, at standard price .. XxX XK XXX 2, Materials are recorded at Actual Price: To record purchase of materials: Materials at actual price ...... Accounts payable, at actual price XXX Xxx b. To record the issuance of materials to production: Work in Process, at standard cost .... Materials Quantity - unfavorable Materials, at actual price ...... Materials Price Usage variance - favorable XXX XXX XXX XXX Direct Labor The direct labor variance is similar 10 the direct materials variance which also arise trom re, ect JOnPE total direct labor variance consists of the rate (price) variance and the tilcioney feuentity) variance. The labor eliciency variance is also called Ine labor time: or usage variance. rignce is the actual rate less the standard rate, times the actual » hows died: actual price - Standard Price) x Actual Hours, i «analysis of vartance ~ it this variance. |s favorable it means less wages per hour were paid than as expected. . eis unfavorable, the supervisor must determine whether workers it this vary assigned to their particular jobs oritis the result of arenegoatiated a oreontiach. Fence it it is outside the control of the management, then Sat standards should be revised. . at ag usually the supervisor of the department or ¢ . Responsibly 7 4 pertormed is responsible for the direct labor rat oa center where e Variance,1008 vi. Chapter 20 e actual hours less the standard hours, B. ie Voriance is th Labor Efficiency (or Usage) Vorianc @, aciua) ovirs} x standard Rale. times the standard rate: (Actual Hours - riance is favorable, it indicates that fewer direct labor hours were used than what is expected. This benefits the company If the labor was efficient; however, if inferior production resulted, this could reduce the quality of the product and cause a negative impact ‘on the entity. + Analysis of variance ~ if this var An unfavorable efficiency variance may be caused by worker's taking unauthorized work breaks which results to the inefficiency of the workers. It may also be caused by production delays resulting from materials shortages or interior materials. + Responsibility - usually the supervisor of the department or cost center in which the work is performed is responsible for the direct labor efficiency variance. Joumal Entries for Direct Labor a. To record Incurrence of Labor: Payroll XXX Accrued Payroll. XXX b. To record Labor Distribution: Work in Process, at standard cost .. XXX Labor Rate Variance - unfavorable ... XXX Payroll = XXX Labor Efficiency Variance — favorable XXX Alternative Approaches to Direct Materials and Direct Labor: 1. Materials and Labor may be transferred to workin i -in-process at their act iti In that case, the direct materials quantity and direct labor efficiency emai may be recognized when goods are transfered from workin-process 10 tnghen goods. 2. The materials price variane 2 Bi oti process. Pl "© may be isolated at the time of transter to work-in- 3. The aificulty with these methods usedis that they delay the recognition of variances Early recognition is desirable for control purposes. Factory Overhead Factory overhead variances are similar to direct materials and direc ‘away that the predetermined costs are compared with actu: factory overhead includes many types ot costs, which are v. procedures for detemining the variances are different, labor varian Ices in 1a Costs. However, because ‘arlable as weil as'fixed, the A. Two-Way Variance. Under this method, the factory overheat 1d Varic - of two componenis: Controllable and Volume variance: | "'ONCe is comprisedse 1009 Controllable Variance: Actual Factory Sos Less: Budget L ed Allowed gc Fixed as Budgeted . Variable ood volume Variance: Budgeted Al bud Stondore oo Based Nn Standard Hour: er Clory Overhead or Applied FO ae ae Net Overhead or Overall Overhead Variance = (F) U = + Analysis of variances Controllable Variance, more or less on fa A vatiance will occur if a company actually spends + than the number fory Overmead than expected and/or uses more OF less i irect labor hours allowed. It assumes a manager OF ; ; upervisor can control these factors (hence controllable variance). Volume variance. This variance might indi e . 7 F ce might indicate the unutilized portion ress in hours that were not effectively applied or over applied during B, Three-Way Variance. Under this method, the factory overhead variance is comprised of three components, however, there are two variations: 1. Spending Variance, Idle Capacity Variance, and Efficiency Variance 2. Spending Variance, Variable Efficiency Variance and Volume Variance Method 1: Spending Variance: Actual Factory Overhead ... : Pxxx Less: Budgeted Allowed Based on Actual Hours: A Fixed as Budgeted z + PXXX, Variable XXX _XXX XXX Idle Capacity Variance: Budgeted Allowed Based on Actual Hours Pa Less: Actual Hours x Standards Rate .---- _ xxx Efficiency Variance: paxx 5 x Standard Rate tees Standard Factory Overhead or Applied FOH _ Xxx Xxx Net Overhead or Overall Overhead Variance = (F) U snrmmnnnen Pxxx Method 2: : Spending Variance: oe XXX verhead aesene ea (Se Sudnolod owed Based on Actual Hou a Fixed as Budgeted - TOK PRRK Variable i i fiance: x. PXxx Variable Efficiency Varianc’ ‘Actual Hours ed on Hours: Budgeted allowed ed pased On standat date Less: Budgeted Aloe” mace Fixed as BudS' Variable ..1010 Chapter 20 Volume Variance: PXxK Budgeted Allowed Based on Standard Hours xxx sex Less: Standard Factory Overhead or Applied FOH . Sete Net Overhead or Overall Overhead Variance ~ (F) U Pa * Analysis of variances ie vari c becouse it is : Spending Variance. This variance is referred to as spending variance i Caused by price changes or changes in operating conditions. If this variance is a result of an extemal force (e.g., power Company Increasing its rates) then these costs are not controllable by management. Idle Capacity Variance. When the actual direct labor hours are different than the expected, @ variance occurs because the fixed costs are a specific amount, but have been either under or over-applied based on the actual direct labor hours, the savings or additional costs of iency of amounts. Efficiency Variance. This variance will indica vorioble overhead due to efficiency or ineffi Variable Efficiency Variance. It is the portion of the efficiency variance that measures the effect of the efficient or inefficient use of the input used as an allocation base on the cost of the variable factory overhead. Volume Variance. This variance might indicate the unutilized portion expressed in hours that were not effectively applied or over applied during the period. ©. Four-Way Variance. Under this method, the factory overhead variance is comprised of four components: Spending variance, Idle Capacity Variance, Variabie Efficiency Variance and Fixed Efficiency Variance: Spending Variance: ‘Actual Factory Overhead .. PXxx Less: Budgeted Allowed Bas Fixed as Budgeted a PXKX Variable XXX XXX PAXX Idie Copacity Variance: Budgeted Allowed Based on Actual Hours .. Pxxx Less: Actual Hours x Standard Rate . XXX XXX Efficiency Variances: Variable Efficiency Variance: Actual Hours .. _ xx Less: Standard Hours ee Efficiency Hours ~ (F) U.... x Variable Overhead Rate Pagan Fixed Efficiency Variance: CHUA! HOUTS sone Less: Standard Hours a Efficiency Hours - (F) U x: Fixed Overhead Rate ae Pr xX. Net Overhead or Overall Overhead Variance ~ (F) u ..standard Costing 1011 * Analysis of variance Fixed Efficie Measures the atiecnane®; I the portion of the efficiency variance that Allocation base Geyer, Ne etlicient or inefficient use of the input used as on € On the Cost of the fixed factory overhead. Alternative: Co : 4 Vornocble Voriance: Spending Variance plus Voriable Efficiency Voriance nce: Volume Variance plus Fixed Efficiency Variance Note: A lot of altemative formulas indi fiances) Can be tied To compute The auove vorancen” fete me ter afore Joumal Entries for Factory Overhead (Two-Variance Method) a. To record Incurrence of Factory Overhead: Factory Overhead Control ..... vsneee mae Cash, Materials, Payroll, Accumulated Depreciation, Prepaid Insurance, etc. .. Xxx b. To record Factory Overhead Applied to Production: Work in Process, at standard cost... Controllable Variance - unfavorable .. Factory overhead control Volume Variance - favorat XxX XXX Xxx XXX Vil. Variances in the Ledger Accounts. ‘i financial statements of a company. They cre Variances usually do not appear on the financial Used for monagerial control and are recorded in the ledger accounts. Vill, Disposition of Variances 1. Immaterial variances are customarily Heated os period cost as an acjustment to id account or income summary. ; f Cost of goods sole cr Gterial may be prorated. A simple opproach to allocation is 2. Variances {hat Eyal net varince (materials, labor, and overhead) to work in to allocate the Nore ds. and cost of goods sold based on the balances in those process. fever there might be some other methods to be used. ac ; A