**Understanding Production Order Variance – Part 1**

**Managerial Accounting – Performance Evaluation Through Standard Costs**

**Author: Ranjit Simon John**

*. Time, resource, money, effort, effectiveness etc are in one instance or the other equated to*

**profit***. We can say all these words can be consolidated and merged into “*

**profit***Efficiency*“. By measuring the efficiency of a firm we can calculate the profit and by improving the efficiency the profit margin grows. Lets drill down to find the ingredients of “

*Efficiency*“. Efficiency focuses on the cost of accomplishing the task.

*Efficiency*” with an example. To evaluate the effectiveness of a product produced the following questions has to be answered effectively;

- Was the best cost obtained in purchasing raw materials.
- Whether the specified quantity of raw material was used.
- Was extra raw materials used
- Was the specified amount and level of overheads used
- Was the task completed within specified time

**STANDARDS**“

*price should only be followed while valuating finished and semi finished goods, not the*

**actual****price. The starting point of better controlling begins with better “**

*standard**STANDARD*“, let it be for price determination or for employee performance evaluation.

*STANDARD*“.

*amount, whereas a budget is a*

**Unit***amount.*

**Total**- Facilitate Management Planning by establishing expected future costs
- Makes employees more “
*Cost Conscious*” - Useful for Setting “Selling Price” for finished goods
- Contribute to Management Control by providing a basis for evaluating the performance of managers responsible for controlling costs.
- Performance may be evaluated through management by exception, as deviations (or Variances) from standard are highlighted
- When standard costs are incorporated into the accounting system, they simplify the costing of inventories and reduce clerical costs.
- Provides a clear overview of the entire process in the company.

*Ideal Standards*or

*Normal Standards.*

**should be under continuo’s review and should be changed whenever it is determined that the existing standard is not good measure of performance.**

*Standards***1) Direct Materials:**

*Direct Materials Price Standard*

**direct materials price standard**is the cost per unit of direct materials that should be incurred. This standard should be the Cost of raw materials, which is frequently based on an analysis of current purchase prices.

Item / Unit |
Price |
---|---|

Raw Material Purchase Price | 2.70 |

Transportation Charge | 0.20 |

Receiving and Handling | 0.10 |

Standard Direct Material Price Per Ton | 3.00 |

*Direct Materials Quantity Standard*

**direct materials quantity standard**is the quantity of direct materials thats should be used per unit of finished goods. The standard is expressed as a physical measure. Consideration should be given to both the quality and quantity of material required to manufacture the product. The standard should include allowances for unavoidable waste and normal spoilage.

Item |
Quantity |
---|---|

Required Raw Material | 3.50 |

Allowance for Waste | 0.40 |

Allowance for Spoilage | 0.10 |

Standard Direct Materials Quantity per Unit | 4.00 |

The Standard Direct Material Cost Per Unit = Standard Direct Material Price x Standard Direct Materials Quantity |

**2) Direct Labor**

*Direct Labor Price Standard*

**direct labor price standard**is the rate per hour that should be incurred for direct labor.

Item |
Price |
---|---|

Hourly Wage Rate | 7.50 |

Cost of Living | 0.25 |

Other benifits | 2.25 |

Standard Direct Labor Rate / Hour | 10.00 |

*Direct Labor Quantity Standard*

**direct labor quantity standard**is the time that should be required to make one unit of the product.

Item |
Quantity |
---|---|

Actual Production Time | 1.50 |

Rest Periods and Cleanup | 0.20 |

Setup and Downtime | 0.30 |

Standard Direct Labor Hours Per Unit | 2.00 |

The Standard Direct Labor Cost Per Unit = Standard Direct Labor Rate x Standard Direct Labor Hours |

**3) Manufacturing Overhead**

BudgetedOverhead Costs |
Amount |
StandardDirectLabor Hours |
Overhead RatePer DirectLabor Hour |
---|---|---|---|

Budgeted Overhead Costs Ampunt |
/ Standard Direct Labor Hour | = |
Overhead Rate Per Direct Labor Hour |

Variable | 79,200.00 | 26,400.00 | 3.00 |

Fixed | 52,800.00 | 26,400.00 | 2.00 |

Total | 132,000.00 | 26,400.00 | 5.00 |

The Standard Manufacturing Overhead Rate Per Unit = Predetermined Overhead Rate x Direct Labor Quantity Standard |

Manufacturing Cost Elements |
Standard Quantity x |
Standard Price = |
Standard Cost |
---|---|---|---|

Direct Materials | 4 TON | 3 | 12.00 |

Direct Labor | 2 Hours | 10 | 20.00 |

Manufacturing Overheads | 2 Hours | 5 | 10.00 |

Total Manufacturing Cost | 42.00 |

**Determining Variances from Standards**

*Variances*.

*Variances*are the differences between total actual costs and total standard cost. The process by which the total difference between standard and actual results is analysed is known as variance analysis. When actual results are better than the expected results, we have a favourable variance (

**F**). If, on the other hand, actual results are worse than expected results, we have an adverse (

**A**).

- Planning variances

– Input price variance

– Resource-usage variance

– Input quantity variance

– Remaining input variance

– Scrap variance

- Production variances

– Input price

– variance

– Resource-usage variance

– Input quantity variance

– Remaining input variance

- Production variance of the period

– Input price

– variance

– Resource-usage variance

– Input quantity variance

– Remaining input variance

– Scrap variance

– Mixed-price variance

– Output price variance

– Lot size variance

- Total variance

– Input price

– variance

– Resource-usage variance

– Input quantity variance

– Remaining input variance

– Scrap variance

– Mixed-price variance

– Output price variance

– Lot size variance

– Remaining variance

* In make-to-stock production, standard cost is calculated in the standard cost estimate for the material. In sales-order-related production with a valuated sales order stock, standard cost is determined using a predefined valuation strategy.

* During production, actual costs are collected on the order (product cost collector or manufacturing order). The actual costs that are compared with the target costs are reduced by the work in process and scrap variances (the result is called the *net actual cost*).

* We can determine the production variances of the period by comparing an alternative material cost estimate with the (net) actual costs. This alternative material cost estimate can be the modified standard cost estimate or the current cost estimate, for example.

Item |
Amount |
---|---|

Direct Materials | 13,020.00 |

Direct Labor | 20,580.00 |

Variable Overhead | 6,500.00 |

Fixed Overhead | 4,400.00 |

Total Actual Cost | 44,500.00 |

Actual Cost | 44,500.00 |

Standrad Cost | 42,000.00 |

Total Variance | 2,500.00 (A) |

*unfavourable (A)*. Thus, the 2,500.00 variance is unfavourable. An unfavourable variance has a negative connotation. It suggests that

**was paid for one or more manufacturing cost elements or that the elements were**

*too much**.*

**used inefficiently***favourable (F)*. A favourable variance has a positive inference. It suggests efficiencies in incurring manufacturing costs and in using direct materials, direct labour, and manufacturing overhead. Favourable variance can also be by using inferior quality materials.

**For each Cost element a total variance is calculated. Then this variance is analyzed into a price variance and a quantity variance.**

**Direct Material Variance**

**total material variance**is computed from the following formual;

**material price variance**is computed from the formula given below

**material quantity (usage) variance**is determined from the following formula;

Item |
Variance |
---|---|

Material Price Variance |
420 |

Material Quantity VAriance |
600 |

Total Material Variance | 1,020 (A) |

**Variance Matrix**

**When the matrix is used, the formulas for each cost element ar computed first and then the variances.**

**Direct Labor Variance**

**total labor variance**is obtained from the formula;

**labor price (or rate) variance**is calculated using the formula;

**labor quantity (or efficiency) variance**is calculated using the formula;

Item |
Variance |
---|---|

Labor Price Variance |
(420) |

Labor Quantity Variance |
1,000 |

Total Direct Labor Variance | 580 (A) |

*When idle time occurs the efficiency variance is based on hours actually worked (not hours paid for) and an idle time variance (hours of idle time x standard rate per hour) is calculated.***Manufacturing Overhead Variance**

**Total Overhead Variance****total overhead variance**is the difference between actual overhead costs and overhead costs applied to work done. With standard costs, manufacturing overhead costs are applied to work in process on the basis of the

**standard hours allowed**for the work done.

**Standard hours allowed**are the hours that

*worked for the units produced. In the example company A’s standard hours allowed for completing work B is 2,000 and the predetermined overhead rate is 5 per direct labor hour. Thus overhead applied is 10,000 (2,000 x 5)*

**should****have been***Note: The actual hours of direct labor are not used in applying manufacturing overhead.*

*price variance*is the

*overhead controllable variance*, whereas the

*quantity variance*is referred to as the

*overhead volume variance*.

**Overhead Controllable Variance****overhead controllable variance**(also called the

**budget**or

**spending variance**) is the difference between the actual overhead costs incurred and the budgeted costs for the

**standard hours allowed.**The budgeted costs are determined from the flexible manufactruning overhead budget.

**Overhead Volume Variance:****overhead volume variance**indicates whether plant facilities were efficiently used during the period. The formula for calculating overhead volume variance is as follows;

*unfavourable*) is 400

**the overhead volume variance relates solely to fixed costs.**Thus,

**the volume variance measures the amount that fixed overhead costs are under -or over applied.**

Overhead controllable variance | 500 |

Overhead volume variance | 400 |

Total Overhead Variance | 900 |

**Cause of Vraicnes**

*” by Weygandt. Kieso. Kell*

**Accounting Principles**
Why do many pictures not display?

Could you modify the pictures?

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I am able to see the pics. can you let me know which pics are not getting displayed.

Thanks a lot for this. Great one.

Hi.

Nice doc!

Very nice document !!!!!!!!!

thanks

Thanks Ranjit,

It is lifetime saver,

Regards,

Devendra

Thank You Devendra, Good to know it helped

Hi Ranjit,

At first i would like to thank you for the blog.

I have a query:-

I see you have mentioned that "

Thus total overhead variance for Comapny A is 900.10900-10000=900" in the section- "Manufacturing Overhead Variance".Can you please elaborate how the value 10900 is arrived here.

Thanks in advance.

Its really helpful to understand the business...thanq so much...

Thank you, Its an interesting read, helping to understand production easing analysis and reporting

Great article.

I understand that adverse variance is definitely not a good thing, but is it a good thing to have 'favorable' production variance? Should a company aim to minimize/reduce the production variance, (adverse or favorable)?

Thanks