Post on 02-Jan-2016
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CHAPTER 24CHAPTER 24
CONTROL THROUGHSTANDARD COSTS
Caution! This chapter is second only to Caution! This chapter is second only to Chapter 15 (bonds) for the amount of grief Chapter 15 (bonds) for the amount of grief
it causes most students in this course.it causes most students in this course.
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Up to this point in the course, we have been using actual costs.
This chapter considers standard costs (i.e., what costs should be under stated conditions). The achievement of standard represents
a reasonable and acceptable level of performance.
Standards for materials, labor, and overhead are determined through engineering studies and time and motion studies.
Nature of Standard CostsNature of Standard Costs
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Nature of Standard CostsNature of Standard Costs
Standard Costs are
Based on carefullypredetermined amounts.
Used for budgeting labor, materialand overhead requirements.
Used for variance analysis.
Benchmarks formeasuring performance.
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Type of Product Cost
Am
ou
nt
DirectMaterial Direct
Labor ManufacturingOverhead
Actual costsStandard costs - what costs should be under
stated conditions.
Nature of Standard CostsNature of Standard Costs
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Type of Product Cost
Am
ou
nt
DirectMaterial Direct
Labor ManufacturingOverhead
Standard cost variances -amounts by which
actual costs differs fromstandard costs.
Standard Cost VariancesStandard Cost Variances
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Type of Product Cost
Am
ou
nt
DirectMaterial Direct
Labor ManufacturingOverhead
The materials variance is unfavorable because the actual
cost exceeds the standard cost.
The overhead variance is favorable becausethe actual cost is less
than the standard cost.
Standard Cost VariancesStandard Cost Variances
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Type of Product Cost
Am
ou
nt
DirectMaterial Direct
Labor ManufacturingOverhead
Managers focus on standard cost variances, a practice known as
management by exception.
Standard Cost VariancesStandard Cost Variances
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Standard Cost VariancesStandard Cost Variances
Why are variancesimportant to me?
They point to causes ofproblems and directions
for improvement.
They trigger investigations in departments having
responsibility for incurringthe costs.
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Setting Standard CostsSetting Standard Costs
Should we usepractical standardsor ideal standards?
Engineer
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Setting Standard CostsSetting Standard Costs
Practical standards should beset at levels that are currentlyattainable with reasonable and
efficient effort.
Productionmanager
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Setting Standard CostsSetting Standard Costs
I agree. Ideal standards, that are based on perfection, are
unattainable and therefore discouraging to most employees.
HumanResourcesManager
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Setting Standard CostsSetting Standard Costs
This is your decision. I’m here to advise you and account for the
resulting transactions.
ManagerialAccountant
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Advantages of Standard CostsAdvantages of Standard Costs
Advantages Cost savings inrecord-keeping
Improved cost control and performance
evaluation
Better Informationfor planning anddecision making
Possible reductionsin production costs
More reasonableand easier inventory
measurements
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Disadvantages of Standard CostsDisadvantages of Standard Costs
DisadvantagesEmphasis onnegative
exceptions maylower morale.
Emphasis on negativeexceptions may
lead to under-reporting.
It may be difficultto determine
which variancesare significant.
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Are standards the same as budgets?
A standard is the expected cost for one
unit.
A budget is the expected cost for all
units.
Use of Standard Costs in Use of Standard Costs in Developing BudgetsDeveloping Budgets
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The total standard cost for one unit of finished product is the sum of: Standard cost for direct materials
Standard cost for direct labor
Standard cost for manufacturing overhead
necessary to produce one unit of the product.
Types of Standard CostsTypes of Standard Costs
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Setting StandardsSetting StandardsDirect MaterialsDirect Materials
UsageStandards
PriceStandards
Use product design specifications
Use competitivebids for the quality
and quantity desired
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Standard CostsStandard CostsDirect MaterialsDirect Materials
Standard costcost for direct materials is standard priceprice for one unit of raw
material (pound, yard, etc.) multiplied by the standard quantityquantity of raw material
to produce one unit of product
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Standard priceprice is the amount that should be paid for each unit of raw material.
Standard quantityquantity is the amount of raw material that should be used to produce one unit offinished product.
The standard material costcost for one unit of product is:
standard quantityquantity standard priceprice for of material one unit of material required for one
unit of product
×
Standard CostsStandard CostsDirect MaterialsDirect Materials
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Standard CostsStandard CostsDirect Materials ExampleDirect Materials Example
Standard priceprice is the amount that should be paid for each unit of raw material.e.g.., each sheet of plywood should cost $6
Standard quantityquantity is the amount of material that should be used to produce one unit of finished product.e.g., each table should take 5 sheets
The High Point Furniture Company makes top quality tables from sheets of plywood.
863
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Standard priceprice is the amount that should be paid for each unit of raw material.e.g.., each sheet of plywood should cost $6
Standard quantityquantity is the amount of material that should be used to produce one unit of finished product.e.g., each table should take 5 sheets
Standard costcost is standard priceprice times standard quantityquantity for one unit of producte.g., $6 X 5 sheets = $30
Standard CostsStandard CostsDirect Materials ExampleDirect Materials Example
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EfficiencyStandards
RateStandards
Use time and motion studies for
each labor operation
Use wage surveys and
labor contracts
Setting StandardsSetting StandardsDirect LaborDirect Labor
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Standard costcost for direct labor is standard wagewage raterate for one hour of
labor multiplied by the standard number of labornumber of labor hours needed to
produce one unit of product.
Standard CostsStandard CostsDirect LaborDirect Labor
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Standard wage ratewage rate is theamount that should be paidfor each hour of labor.
Standard number of hoursnumber of hoursis the number of hours thatshould be worked to produceone unit of finished product.
The standard labor costcost for one unit of product is:
standard numbernumber standard wage ratewage rate of labor hoursof labor hours for one hour for one unit of product
×
Standard CostsStandard CostsDirect LaborDirect Labor
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The High Point Furniture Company’s dining room tables are made by highly
skilled, hourly paid carpenters. Standard wage ratewage rate is the amount that
should be paid for each hour of labor.e.g.., each hour should cost $10
Standard number of hoursnumber of hours is the number of hours that should be worked to produce one unit of finished product.e.g., each table should take 2 hours
Standard CostsStandard CostsDirect Labor ExampleDirect Labor Example
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Standard wage ratewage rate is the amount that should be paid for each hour of labor.e.g.., each hour should cost $10
Standard number of hoursnumber of hours is the number of hours that should be worked to produce one unit of finished product.e.g., each table should take 2 hours
Standard labor costcost is standard wage wage raterate times standard number of hoursnumber of hours for one unit of finished producte.g., $10 X 2 hours = $20
Standard CostsStandard CostsDirect Labor ExampleDirect Labor Example
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Standard Rate
Select a standard level of output and define
a basis for activity
Setting StandardsSetting StandardsManufacturing OverheadManufacturing Overhead
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.
Standard CostsStandard CostsManufacturing OverheadManufacturing Overhead
If, however, the overhead rate is based on units of inputinput such as direct labor hours, the denominator is
based on the inputinput labor hours.
The above calculation is really what?
Total budgeted overhead costat the standard level of output
Standard level of output
Standard overhead raterate per unit =
A standard manufacturing overhead raterate is applied for each unit of activity.
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Budgeted overhead costBudgeted overhead cost is thetotal amount of overhead cost that should be incurred for the year to produce at the standard level of output.
StandardStandard level of output level of output is what the activity level for the cost driver should be for the year.
Total budgeted overhead costbudgeted overhead costat the standard level of output
StandardStandard level of outputlevel of output
Standard overhead raterate per unit =
Standard CostsStandard CostsManufacturing OverheadManufacturing Overhead
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Budgeted overhead costBudgeted overhead cost is the amount of overhead cost that should be incurred to produce at the standard level of output.e.g., total overhead cost = $100,000
StandardStandard level of outputlevel of output is what the activity level for the cost driver should be.e.g., total labor hours should be 20,000
Standard CostsStandard CostsManufacturing Overhead ExampleManufacturing Overhead Example
The High Point Furniture Company applies overhead to tables based on machine hours.
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Budgeted overhead costBudgeted overhead cost is the amount of overhead cost that should be incurred to produce at the standard level of output.e.g., total overhead cost = $100,000
StandardStandard level of outputlevel of output is what the activity level for the cost driver should be.e.g., total labor hours should be 20,000
Total budgeted overhead costbudgeted overhead costat the standard level of output
StandardStandard level of outputlevel of output
Standard overhead raterate per unit =
Standard CostsStandard CostsManufacturing Overhead ExampleManufacturing Overhead Example
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Budgeted overhead costBudgeted overhead cost is the amount of overhead cost that should be incurred to produce at the standard level of output.e.g., total overhead cost = $100,000
StandardStandard level of outputlevel of output is what the activity level for the cost driver should be.e.g., total labor hours should be 20,000
Standard overheadraterate per unit (i.e, hour) =
$100,000
20,000= $5
Standard CostsStandard CostsManufacturing Overhead ExampleManufacturing Overhead Example
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Budgeted overhead costBudgeted overhead cost is the amount of overhead cost that should be incurred to produce at the standard level of output.e.g., total overhead cost = $100,000
StandardStandard level of outputlevel of output is what the activity level for the cost driver should be.e.g., total labor hours should be 20,000
Standard overhead costcost is standard overhead raterate times number of activity units for each unit of finished producte.g., $5 X 2 labor hours = $10
Standard CostsStandard CostsManufacturing Overhead ExampleManufacturing Overhead Example
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Standard Costs For One Table
Direct materials - $6 X 5 sheets $30
Direct labor - $10 X 2 hours 20
Manufacturing overhead - $5 X 2 labor hours 10
Total standard cost $60
Standard CostsStandard CostsSummary of ExamplesSummary of Examples
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Computing VariancesComputing Variances
Standard cost variance
Amount by which actual cost differs from standard cost for the for the actualactual volume level volume level attainedattained
Favorable variance
Actual cost is less than standard cost
Unfavorable variance
Actual cost is greater than standard cost
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Know how to calculate all six cost variances and what causes each.
* For the actual volume level attained
*
*
***
Computing VariancesComputing Variances872
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Let’s use what we have learned to calculate the six
standard cost variances for a
different company, starting with
direct materials.
Computing VariancesComputing Variances
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Hanson Inc. has the following material standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Records last week show 1,700 pounds of material were purchased in May at a
total cost of $6,630. The material was used to make 1,000 Zippies in May.
Computing VariancesComputing VariancesMaterials Price VarianceMaterials Price Variance
AP = $6,630 ÷ 1,700 lbs AP = $3.90 per lb MPV = (AP - SP) x AQ MPV = ($3.90 - 4.00) x 1,700 lbs. MPV = -$170 Favorable
Materials Price
Variance
Zippy
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Hanson Inc. has the following material standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Records last week show 1,700 pounds of material were purchased in May at a
total cost of $6,630. The material was used to make 1,000 Zippies in May.
AP = $6,630 ÷ 1,700 lbs AP = $3.90 per lb MPV = (AP - SP) x AQ MPV = ($3.90 - 4.00) x 1,700 lbs. MPV = -$170 Favorable
Note that the authors’ use of +/- is counter-
intuitive
Computing VariancesComputing VariancesMaterials Price VarianceMaterials Price Variance
Zippy
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GENERAL JOURNAL
Page: 1
Date Description PR Debit Credit
5/10 Materials Inventory 6,800 Materials Price Variance 170 Accounts Payable 6,630
To record purchase of materials
at less than standard cost
*
Materials inventory must always be debited for the actual actual quantity X standard standard price
1,700 lbs. X $4.00 = $6,800
*
Price variance is recorded at time of purchase.
Recording VariancesRecording VariancesMaterials Price VarianceMaterials Price Variance
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Hanson Inc. has the following material standard to manufacture one Zippy:
1.5 pounds per Zippy at $4.00 per pound
Records last week show 1,700 pounds of material were purchased in May at a
total cost of $6,630. The material was used to make 1,000 Zippies in May.
Materials Usage
Variance
SQ = 1,000 units × 1.5 lbs per unit SQ = 1,500 lbs MUV = (AQ - SQ) x SP MUV = (1,700lbs - 1,500lbs) x $4.00
MUV = +$800 unfavorable
Computing VariancesComputing VariancesMaterials Usage VarianceMaterials Usage Variance
Zippy
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GENERAL JOURNAL
Page: 1
Date Description PR Debit Credit
5/10 Work in Process Inventory 6,000Materials Usage Variance 800 Materials Inventory 6,800
To record use of materials and
establish materials usage variance
Materials inventory must always be relieved for the actual actual quantity X standard standard price
1,700 lbs. X $4.00 = $6,800
*
*
Recording VariancesRecording VariancesMaterials Usage VarianceMaterials Usage Variance
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GENERAL JOURNAL
Page: 1
Date Description PR Debit Credit
5/10 Work in Process Inventory 6,000Materials Usage Variance 800 Materials Inventory 6,800
To record use of materials and
establish materials usage variance
Work in Process Inventory must always be debited for the standard standard quantity X standard standard price
(1,000 units X 1.5 lbs.) X $4.00 = $6,000
*
*
Usage variance is recorded at time of use.
Can materials price and usage variances be added to get a total materials variance?
Recording VariancesRecording VariancesMaterials Usage VarianceMaterials Usage Variance
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Now let’s calculate standard cost variances for direct labor.
Computing VariancesComputing Variances
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Hanson Inc. has the following labor standard to manufacture one Zippy:
1.5 standard hours per Zippy at $6.00 per hour
Payroll records show 1,450 hours were worked at a total labor cost of $8,990 to
make 1,000 Zippies.
Computing VariancesComputing VariancesLabor Rate VarianceLabor Rate Variance
Labor Rate
Variance
AR = $8,990 ÷ 1450 hours AR = $6.20 per hour
LRV = (AR - SR) X AH LRV = ($6.20 - $6.00) X 1,450 hrs
LRV = +$290 unfavorable
Zippy
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Hanson Inc. has the following labor standard to manufacture one Zippy:
1.5 standard hours per Zippy at $6.00 per hour
Payroll records show 1,450 hours were worked at a total labor cost of $8,990 to
make 1,000 Zippies.
Labor Efficiency Variance
SH = 1,000 units × 1.5 hours per unit SH = 1,500 hours LEV = (AH - SH) X SR LEV = (1,450 hrs - 1,500 hrs) X $6.00 LEV = -$300 favorable
Computing VariancesComputing VariancesLabor Efficiency VarianceLabor Efficiency Variance
Zippy
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Recording VariancesRecording VariancesLabor Rate & Efficiency VariancesLabor Rate & Efficiency Variances
GENERAL JOURNAL
Page: 1
Date Description PR Debit Credit
5/15 Work in Process Inventory 9,000Labor Rate Variance 290 Labor Efficiency Variance 300 Payroll Summary 8,990
To charge work in process for direct
labor and to establish variances
Note that unlike materials variances, both labor variances are recorded at the same time. (i.e., when
the payroll summary account is cleared out.)
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.
GENERAL JOURNAL
Page: 1
Date Description PR Debit Credit
5/15 Work in Process Inventory 9,000Labor Rate Variance 290 Labor Efficiency Variance 300 Payroll Summary 8,990
To charge work in process for direct
labor and to establish variances
* Work in Process Inventory must always be debited for the standard standard quantity X standard standard price
(1,000 units X 1.5 lbs.) X $6.00 = $9,000
*
*
Source?
Recording VariancesRecording VariancesLabor Rate & Efficiency VariancesLabor Rate & Efficiency Variances
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Now let’s calculate standard cost variances for
manufacturing overhead.
Computing VariancesComputing Variances
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Overhead is applied to goods produced using a standard overhead raterate.
Overhead rate is set prior to the start of the period.
Total budgeted overhead costat the standard level of outputstandard level of output
Standard level of outputStandard level of output
Standard overhead raterate per unit =
Standard Overhead RateStandard Overhead Rate
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Standard Overhead Rate
per unit
Contains a variable variable per unit component which stays constant at all
levels of activity.
Contains a fixed fixed per unit component which
declines as activitylevel increases.
Is a function of the projected volumelevel chosen to determine the rate.
(i.e., standard level of outputstandard level of output)
Standard Overhead RateStandard Overhead Rate
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Budget Variance
Is calculated as the difference between total actualactual overhead cost and budgetedbudgeted amount of overhead for the actual volume attainedfor the actual volume attained
Volume VarianceIs calculated as the difference between the
budgetedbudgeted amount of overhead for the actual volume level attainedfor the actual volume level attained
and the appliedapplied overhead at the standard level of outputstandard level of output
Overhead VariancesOverhead Variances
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Overhead VariancesOverhead Variances Budgeted Applied Overhead at Overhead at Actual Actual VolumeActual Volume Standard LevelStandard Level Overhead Level AttainedLevel Attained of Outputof Output
Budget Variance
VolumeVariance
AOH - BOH BOH - Applied OH
AOH = Actual Overhead BOH = Budgeted Overhead
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Overhead VariancesOverhead Variances
Budget Variance
VolumeVariance
Budgeted Applied Overhead at Overhead at Actual Actual VolumeActual Volume Standard LevelStandard Level Overhead Level AttainedLevel Attained of Outputof Output
Total Overhead Variance
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Total Overhead Variance
Overhead VariancesOverhead Variances
Budget Variance
VolumeVariance
Shows how economicallyoverhead services were
purchased and howefficiently overheadservices were used.
Contains both fixedand variable costs.
Budgeted Applied Overhead at Overhead at Actual Actual VolumeActual Volume Standard LevelStandard Level Overhead Level AttainedLevel Attained of Outputof Output
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Total Overhead Variance
Overhead VariancesOverhead Variances
Budget Variance
VolumeVariance
Caused by producing ata level other than that
used for computing thestandard overhead rate.
Contains only fixed costs.
Budgeted Applied Overhead at Overhead at Actual Actual VolumeActual Volume Standard LevelStandard Level Overhead Level AttainedLevel Attained of Outputof Output
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Flexible budgets, showing budgeted amount of overhead for various
levels of activity, are used to analyze overhead costs.
Overhead VariancesOverhead Variances
Hanson’s flexiblebudget for overhead
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Overhead VariancesOverhead VariancesExampleExample
Hanson, Inc. has the following flexible budget for overhead:
Hanson applies overhead based on machine hour activityand expects to produce 1,500 Zippies.
(i.e., a standard activity level standard activity level of 3,000 machine hours)
Machine Hours 2,000 3,000 4,000 Zippies 1,000 1,500 2,000
Variable Overhead 4,000$ 6,000$ 8,000$ Fixed Overhead 9,000 9,000 9,000 Total Overhead 13,000$ 15,000$ 17,000$
Zippy
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Machine Hours 2,000 3,000 4,000 Zippies 1,000 1,500 2,000
Variable Overhead 4,000$ 6,000$ 8,000$ Fixed Overhead 9,000 9,000 9,000 Total Overhead 13,000$ 15,000$ 17,000$ Variable Overhead Rate $6,000 ÷ 3,000 machine hours = $2.00 per machine hour (constant at all activity levels)
Fixed Overhead Rate $9,000 ÷ 3,000 machine hours = $3.00 per machine hour (different at each activity level)
Overhead VariancesOverhead VariancesExampleExample
Zippy
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Hanson’s actual production for the period was 1,600 Zippies resulting in
3,200 standard machine hours. Actual total overhead cost for the period was
$15,450.
Overhead VariancesOverhead VariancesExampleExample
Zippy
Compute the overhead budget and volume variances.
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$15,450 $9,000 fixed + $6,400 variable
$2.00 per hr. × 3,200 hrs.
$15,450 $9,000 fixed 3,200 hrs. + × $6,400 variable $5.00 per hr.
$2.00 per hr. variableplus
$3.00 per hr. fixed
Overhead VariancesOverhead VariancesExampleExample
Zippy
Budgeted Applied Overhead at Overhead at Actual Actual VolumeActual Volume Standard LevelStandard Level Overhead Level AttainedLevel Attained of Outputof Output $15,450
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Budget variance$50 unfavorable
Volume variance$600 favorable
$15,450 $9,000 fixed 3,200 hrs. + × $6,400 variable $5.00 per hr.
$15,450 $15,400 $16,000
Overhead VariancesOverhead VariancesExampleExample
Zippy
Budgeted Applied Overhead at Overhead at Actual Actual VolumeActual Volume Standard LevelStandard Level Overhead Level AttainedLevel Attained of Outputof OutputLet’s try a slightly
different approach for getting the $15,400 of Budgeted Overhead.
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Machine Hours 2,000 3,000 4,000 Zippies 1,000 1,500 2,000
Variable Overhead 4,000$ 6,000$ 8,000$ Fixed Overhead 9,000 9,000 9,000 Total Overhead 13,000$ 15,000$ 17,000$
Overhead VariancesOverhead VariancesExampleExample
Hanson’s flexible budget for overhead
Standard Standard activity activity
levellevel
100% 133% 67%
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Machine Hours 2,000 3,000 3,200 Zippies 1,000 1,500 1,600
Variable Overhead 4,000$ 6,000$ 6,400$ Fixed Overhead 9,000 9,000 9,000 Total Overhead 13,000$ 15,000$ 15,400$
Overhead VariancesOverhead VariancesExampleExample
Hanson’s flexible budget for overhead
Standard Standard activity activity
levellevel
100% 107% 67%
Actual Actual volume volume
level level attainedattainedBOH
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GENERAL JOURNAL
Page: 1
Date Description PR Debit Credit
5/31 Manufacturing Overhead 550Overhead Budget Variance 50 Overhead Volume Variance 600
To record overhead variances and
close manufacturing overhead
Overhead account is closed and both variances are recorded at end of period in the same entry.
Recording Overhead VariancesRecording Overhead Variances
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Investigating VariancesInvestigating Variances The decision to investigate a variance is
based on: Dollar amount of variance. Size of variance relative to cost incurred. Controllability of cost associated with
variance.All of these relate to the “Management by Exception” concept
Variances may be interdependent. Performance reports contain variances
along with budgeted and actual cost data.
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Variance Analysis andVariance Analysis andManagement by ExceptionManagement by ExceptionNow that I know all about
standard cost variances, howdo I apply that management
by exception concept?
Well, sir, you should keep in mind what my daddy taught me: "If it ain't broke, don't fix it” and
"Don't sweat the small stuff."
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Can you tell mewhich variances to
investigate?
Variance Analysis andVariance Analysis andManagement by ExceptionManagement by Exception
Type of Product Cost
Am
ou
nt
DirectMaterialDirect
Labor ManufacturingOverhead
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Possible guidelines are:Dollar amount or percentage of the standard Controllability of the cost variance
Variance Analysis andVariance Analysis andManagement by ExceptionManagement by Exception
Can you tell mewhich variances to
investigate?
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.
Variance may be closed entirely to Cost of Goods Sold (normal case for small variances) or
Variance may be closed by prorating to Work in Process, Finished Goods, and Cost of Goods Sold based on relative size of these accounts.
Disposing of VariancesDisposing of Variances