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Managerial Accounting- HO5 Variance Analysis1Standard Costing and Analysis of VarianceUNIVERSITI KUALA LUMPURMaster of Business AdministrationMANAGERIAL ACCOUNTINGHO 5Managerial Accounting- HO5 Variance Analysis2The Need for StandardsStandards are common in business; those imposed by government agencies are often called regulations. In managerial accounting, standard costs are predetermined unit costs, which are used as measures of performance. The focus in this text is on manufacturing standards; however, standards are applicable to many types of businesses.Managerial Accounting- HO5 Variance Analysis3Distinguishing Between Standards and BudgetsConceptually, standards and budgets are essentially the same. Both are pre-determined costs and both contribute significantly to management planning and control.A standard is a unit amount, whereas a budget is a total amount.A standard is concerned with each individual cost component that makes up the entire budget.Standard costs may be incorporated into a cost accounting system.Managerial Accounting- HO5 Variance Analysis4Why Standard Costs?Carefully established and prudently used standard costs offer the following advantages to an organization:They facilitate management planning.They promote greater economy by making employees more cost conscious.They are useful in setting selling prices.They contribute to management control by providing a basis for the evaluation of cost control.They are useful in highlighting variances in management by exception.They simplify the costing of inventories and reduce clerical costs.Managerial Accounting- HO5 Variance Analysis5Setting Standard CostsThe setting of standard costs to produce a unit of product is a difficult task.Setting standards requires input from all persons who have responsibility for costs and quantities. To be effective in controlling costs, standard costs need to be current at all times. Thus, standards should be under continuous review and should be changed whenever it is determined that the existing standards are not a good measure of performance.Managerial Accounting- HO5 Variance Analysis6Ideal versus Normal StandardsStandards may be set at one of two levels: Ideal standards represent optimum levels of performance under perfect operating conditions. Normal standards represent efficient levels of performance that are attainable under expected operating conditions.Most companies that use standards set them at a normal level. Properly set normal standards should be rigorous but attainable.Managerial Accounting- HO5 Variance Analysis7Total Standard Cost per UnitThe total standard cost per unit is the sum of the standard costs of direct materials, direct labor, and manufacturing overhead. For Xonic, Inc., the total standard cost per gallon of Weed-O is $42, as shown on the following standard cost card:

A standard cost card is prepared for each product. This card provides the basis for determining variances from standards.Product: Weed-OUnit Measure: Gallon

ManufacturingStandard StandardStandard Cost Elements Quantity x Price = Cost Direct materials4 pounds$ 3.00 $12.00 Direct labor2 hours $10.00 $20.00 Manufacturing overhead2 hours $ 5.00 $10.00 $42.00 Managerial Accounting- HO5 Variance Analysis8Variances from StandardsA variance is the difference between total actual costs and total standard costs. When actual costs exceed standard costs, the variance is unfavorable. An unfavorable variance suggests that too much was paid for materials and labor or that there were inefficiencies in using materials and labor. If actual costs are less than standard costs, the variance is favorable. Favorable variances indicate efficiencies in incurring costs and in using materials and labor. However, be careful: a favorable variance could be obtained by using inferior materials.Managerial Accounting- HO5 Variance Analysis9Variances IllustratedTo illustrate variances, assume that in producing 1,000 gallons of Weed-O in the month of June, Xonic, Inc., incurred the following costs:The total standard cost of Weed-O is $42,000 (1,000 gallons x $42). Thus, the total variance is $2,500, as shown:

Direct materials$13,020Direct labor20,580Variable overhead6,500Fixed overhead 4,400Total actual costs$44,500Actual costs$44,500Standard costs 42,000Total variance$ 2,500Managerial Accounting- HO5 Variance Analysis10Analyzing Variances To properly interpret the significance of a variance, you must analyze it to determine the underlying factors. Analyzing variances begins with a determination of the cost elements that comprise the variance. For each manufacturing cost element, a total dollar variance is computed. Then this variance is analyzed into a price variance and a quantity variance.Managerial Accounting- HO5 Variance Analysis11Relationships of VariancesTotalVarianceTotalMaterialsVarianceMaterialsPriceVarianceMaterialsQuantityVariance==+TotalLaborVarianceLaborPriceVarianceLaborQuantityVariance==+TotalOverheadVarianceOverheadControllableVarianceOverheadVolumeVariance==+Illustration 8-10Managerial Accounting- HO5 Variance Analysis12Direct Materials Variances: TotalThe total materials variance is computed from the following formula:

In completing the order for 1,000 gallons of Weed-O, Xonic used 4,200 pounds of direct materials purchased at a cost of $3.10 per unit. For Xonic, Inc., the total materials variance is $1,020 ($13,020 - $12,000) unfavorable as shown below:(4,200 x $3.10) (4,000 x $3.00) = $1,020 UActual Quantityx Actual Price(AQ) x (AP)Standard Quantityx Standard Price(SQ) x (SP)Total MaterialsVariance(TMV)=Illustration 8-25Managerial Accounting- HO5 Variance Analysis13Direct Materials Variances: PriceThe materials price variance is computed from the following formula:

For Xonic, Inc., the materials price variance is $420 ($13,020 - $12,600) unfavorable as shown below:(4,200 x $3.10) (4,200 x $3.00) = $420 UActual Quantityx Actual Price(AQ) x (AP)Actual Quantityx Standard Price(AQ) x (SP)MaterialsPrice Variance(MPV)=Illustration 8-25Managerial Accounting- HO5 Variance Analysis14Direct Materials Variances: QuantityThe materials quantity variance is computed from the following formula:

For Xonic, Inc., the materials quantity variance is $600 ($12,600 - $12,000) unfavorable as shown below:(4,200 x $3.00) (4,000 x $3.00) = $600 UActual Quantityx Standard Price(AQ) x (SP)Standard Quantityx Standard Price(SQ) x (SP)MaterialsQuantity Variance(MQV)=Illustration 8-13Managerial Accounting- HO5 Variance Analysis15Direct Materials Variances: SummaryThe total materials variance of $1,020 (U), therefore, consists of the following:

Materials price variance$ 420 UMaterials quantity variance 600 UTotal materials variance$1,020 UManagerial Accounting- HO5 Variance Analysis16Matrix for Direct Materials VarianceA matrix is sometimes used to determine and analyze a variance.Actual Quantity x Actual Price(AQ) x (AP)4,200 x $3.10 = $13,0201Actual Quantity x Standard Price(AQ) x (SP)4,200 x $3.00 = $12,6002Standard Quantity x Standard Price(SQ) x (SP)4,000 x $3.00 = $12,0003Total Variance $13,020 $12,000 = $1,020 U13Price Variance $13,020 $12,600 = $420 U12Quantity Variance $12,600 $12,000 = $600 U23Illustration 8-15Managerial Accounting- HO5 Variance Analysis17Causes of Materials VariancesThe causes of variances may relate to both internal and external factors.The investigation of a materials price variance usually begins in the purchasing department.A variance may be beyond the control of purchasing such as with inflation or actions by groups over which the company has no control.The starting point for determining the cause(s) of a materials quantity variance is in the production department.A variance may be beyond the control of production, such as with inferior materials bought by purchasing. Managerial Accounting- HO5 Variance Analysis18Direct Labor Variances: TotalThe total labor variance is computed from the following formula:

In completing the order for 1,000 gallons of Weed-O, Xonic incurred 2,100 direct labor hours at an average hourly rate of $9.80. The standard hours allowed for the units produced were 2,000 (1,000 x 2 hours) and the standard rate was $10 per hour.The total labor variance is $580 ($20,580 - $20,000) unfavorable as shown below:(2,100 x $9.80) (2,000 x $10.00) = $580 UActual Hoursx Actual Rate(AH) x (AR)Standard Hoursx Standard Rate(SH) x (SR)Total LaborVariance(TLV)=Managerial Accounting- HO5 Variance Analysis19Direct Labor Variances: PriceThe labor price variance is computed from the following formula:

For Xonic, Inc., the labor price variance is $420 ($20,580 - $21,000) favorable as shown below:(2,100 x $9.80) (2,100 x $10.00) = $420 FActual Hoursx Actual Rate(AH) x (AR)Actual Hoursx Standard Rate(AH) x (SR)LaborPrice Variance(LPV)=Managerial Accounting- HO5 Variance Analysis20Direct Labor Variances: QuantityThe labor quantity variance is computed from the following formula:

For Xonic, Inc., the labor quantity variance is $1,000 ($21,000 - $20,000) unfavorable as shown below:(2,100 x $9.80) (2,000 x $10.00) = $1,000 UActual Hoursx Standard Rate(AH) x (SR)Standard Hoursx Standard Price(SH) x (SR)LaborQuantity Variance(LQV)=Managerial Accounting- HO5 Variance Analysis21Direct Labor Variances: SummaryThe total labor variance of $580 unfavorable, therefore, consists of the following:

Labor price variance$ 420 FLabor quantity variance 1,000 UTotal labor variance$ 580 UManagerial Accounting- HO5 Variance Analysis22Matrix for Direct Labor VarianceActual Hours x Actual Rate(AH) x (AR)2,100 x $9.80 = $20,5801Actual Hours x Standard Rate(AH) x (SR)2,100 x $10.00 = $21,0002Standard Hours x Standard Rate(SH) x (SR)2,000 x $10.00 = $20,0003Total Variance $20,580 $20,000 = $580 U13Price Variance $20,580 $21,000 = $420 F12Quantity Variance $21,000 $20,000 = $1,000 U23Managerial Accounting- HO5 Variance Analysis23Causes of Labor VariancesLabor price variances usually result from two factors:paying workers higher than expected wages, andmisallocation of workers.When companies are not unionized, there is a higher likelihood of these variances.The responsibility of these variances usually rests with the manager that authorized the wage increase or the production department.Labor quantity variances relate to the efficiency of the workers.These variances are usually the responsibility of the production department.