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What is a Standard Cost Variance?

Standard Cost Variance

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Standard Cost Variance

A Standard Cost Variance is the difference between the actual cost incurred for producing a product or providing a service and its standard cost. Standard cost variances are used in managerial accounting to analyze the performance of a business, understand cost behaviors, and identify areas for improvement.

There are several types of standard cost variances, each providing insights into different aspects of the production process:

  1. Direct Materials Variance:
    • Material Price Variance: The difference between the actual cost of materials and the standard cost, based only on the price difference. Calculated as:
      (ActualPrice − StandardPrice) × ActualQuantity
    • Material Usage (or Quantity) Variance: The difference between the actual quantity of materials used and the standard quantity expected, using standard prices. Calculated as:
      (ActualQuantity − StandardQuantity) × StandardPrice
  2. Direct Labor Variance:
    • Labor Rate Variance: The difference between the actual wages paid and the standard cost, based only on the rate difference. Calculated as:
      (ActualRate − StandardRate) × ActualHours
    • Labor Efficiency (or Time) Variance: The difference between the actual labor hours worked and the standard hours expected, using standard rates. Calculated as:
      (ActualHours − StandardHours) × StandardRate
  3. Variable Overhead Variance:
    • Overhead Spending Variance: The difference between the actual variable overhead incurred and the expected (standard) variable overhead based on actual hours worked.
    • Overhead Efficiency Variance: The difference between the expected variable overhead based on actual hours worked and the expected variable overhead based on standard hours for the actual level of production.

Each of these variances can be favorable (F) or unfavorable (U). A variance is considered favorable if the actual costs are less than the standard costs or if actual revenues exceed standard revenues. Conversely, a variance is unfavorable if actual costs exceed standard costs or actual revenues fall short of standard revenues.

Example of a Standard Cost Variance

Let’s construct a fictional example to illustrate the concept of standard cost variance.

Company: Crafty Chairs Inc.

Product: Handmade Wooden Stool

Standard Costs for One Stool:

  • Direct Materials: 5kg of wood @ $10/kg = $50
  • Direct Labor: 3 hours @ $15/hour = $45

Actual Production Data for 100 Stools:

  • Direct Materials Used: 520kg of wood costing $5,200 ($10.40/kg).
  • Direct Labor Used: 320 hours costing $4,960 ($15.50/hour).

Variance Analysis:

  • Direct Materials Variance:
    • Material Price Variance:
      (ActualPrice − StandardPrice) × ActualQuantity
      (10.40−10)×520(10.40−10)×520 = $208 Unfavorableb.
    • Material Usage Variance:
      (ActualQuantity − StandardQuantity) × StandardPrice
      (520kg – (5kg/stool × 100 stools)) × $10 (520kg – 500kg) × $10 = $200 Unfavorable
  • Direct Labor Variance:
    • Labor Rate Variance:
      (ActualRate − StandardRate) × ActualHours
      (15.50−15)×320(15.50−15)×320 = $160 Unfavorableb.
    • Labor Efficiency Variance:
      (ActualHours − StandardHours) × StandardRate
      (320 hours – (3 hours/stool × 100 stools)) × $15 (320 hours – 300 hours) × $15 = $300 Unfavorable

Conclusion:

  • Total Material Variance: $408 Unfavorable (Sum of Material Price and Usage Variances)
  • Total Labor Variance: $460 Unfavorable (Sum of Labor Rate and Efficiency Variances)

From the analysis, Crafty Chairs Inc. has unfavorable variances for both materials and labor. This suggests that they are spending more on materials and labor than what was set in the standards.

Management should investigate why they are using more wood per stool than expected and why it’s taking longer to produce each stool. They should also check if the increased prices for wood and labor rates were due to market conditions or internal factors. Based on the findings, corrective actions can be taken.

Remember, while unfavorable variances often suggest inefficiencies or problems, they can sometimes result from changing market conditions or other factors beyond the company’s control. Thus, the context is crucial when interpreting variances.

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