JOB ORDER, OPERATION AND LIFE CYCLE COSTING

Job Order Costing

Job-order costing is used when each item the company produces is unique and identifiable from
all others.

Operation Costing
 Operation costing is a hybrid, or combination, of job-order costing and process costing.
 A company applies the basic operation of process costing to a production process that
produces batches of items.
 Direct materials are charged to the specific batch where they are used.
 Conversion costs are accumulated and distributed using a predetermined conversion cost
per unit.

Life Cycle Costing

 Useful for internal decision making
 Company does not determine the production cost in the short-term sense of the
production of one unit.
 This longer-term view is of particular importance when the product has significant R&D
costs.

Life Cycle Cost Categories

All of the costs in the life cycle of the company can be broken down into three categories:
1. Upstream costs
2. Manufacturing costs
3. Downstream costs

Customer Life Cycle Costing

 Looks at the cost of the product from the customer’s standpoint.
 It focuses on the total costs that will be paid by the customer during the whole time the
customer owns the product: the customer’s purchase costs plus costs to use, maintain, and
dispose of the product or service.
 Customer life-cycle costing is important to a company because it is part of the pricing
decision.

1: BASIS OF VARIANCE ANALYSIS

Variance Analysis
Variance analysis is the comparison between the actual results for the period and the budgeted
results. Without standard costs, variances could not be done.

Standard Costs
The estimate of the cost the company expects to incur in the production process. It is the standard
against which to measure the actual performance.
Standard Costs and Flexible Budgets
Standard costs are used with a flexible budgeting system.

Reviewing the Standard Cost

The established standard costs need to be reviewed periodically to confirm it is still accurate.

Sources of Standards
 Activity analysis
 Use of historical data
 Benchmarking
 Target costing
 Strategic decisions

2: THE LEVELS OF VARIANCE ANALYSIS

Variance Analysis Levels

There are three levels:
Level 1: Static Budget Variances
Level 2: Flexible Budget and Sales Volume Variances
Level 3: Manufacturing Input and Sales Variances

Limitations of Level 1 Variances

 Variances caused by more or fewer sales than planned are not segregated from variances
caused by other factors.
 Comparison of actual results with the master budget focuses on short-term performance
instead of long-term success.
 The analysis is only financial

Level 2 Variances
This level of variance may be broken down into two sub-variances:
1. The flexible budget variance is the difference between actual results and the flexible
budget amount. (Actual-Flexible)
2. The sales volume variance is the difference between the flexible budget and the static
budget amount. (Flexible-Static)
Level 3 Variances
Manufacturing input variances:
 Direct Materials
 Direct Labor
 Overhead

Sales Variances
Order of Subtraction
 Always subtract the Standard from the Actual:
 Actual - Standard (or Budget) = Variance

Favorable or Unfavorable
 Income Items (same as the result):
 A positive result is a Favorable variance
 A negative result is an Unfavorable variance

Expense Items (opposite of the result):

 A positive result is an Unfavorable variance
 A negative result is a Favorable variance

3: MANUFACTURING INPUT VARIANCES

 Concerned with inputs to the manufacturing process.

 Whether the amount of inputs used per unit manufactured was over or under the
standard
 Whether the per unit of inputs per unit manufactured was over or under the standard

Total input variances are subdivided into:

1. A price variance reflecting the difference between actual and budgeted input prices, and
2. A quantity variance, also called an efficiency variance, reflecting the difference
between actual and budgeted input quantities.

Direct Materials Variances

Total Direct Materials Variances

The total materials variance is the difference between the actual direct material costs and the
expected direct material costs in the flexible budget.
Quantity and Price Variances
The total materials variance may be broken down into two sub variances:
1. The quantity variance, and
2. The price variance

Quantity Variance
- also called the efficiency variance, or the usage variance.
(Actual Quantity - Standard Quantity) x Standard Price

Positive result - unfavorable

Negative result - favorable

Price Variance
Measures the effect on the total variance caused by the actual price being different from the
expected price.
(Actual Price - Standard Price) x Actual Quantity

Positive result - unfavorable

Negative result - favorable
Using the Variance Formulas
In addition to being able to solve for the amount of the variance, you also need to be able to use
these formulas to solve for any of the variables. You also need to be able to understand what may
cause a variance or a combination of variances.

Direct Labor Variance

Total Direct Labor Variance
The total labor variance is the difference between the actual labor costs and the expected labor
costs in the flexible budget.

Rate (Price) and Efficiency (Quantity) Variances

The total labor variance may be broken down into two sub variances:

Labor Rate Variance

The labor rate variance measures the effect on the total variance that was caused by the actual
labor rate being different from the expected labor rate.
(Actual Price - Standard Price) x Actual Quantity

Positive result - unfavorable

Negative result - favorable

Labor Efficiency Variance

The efficiency variance measures the effect on the total variance that was caused by the actual
quantity used being different from the expected quantity to be used for the actual level of output
that was produced.
(Actual Quantity - Standard Quantity) x Standard Price

Positive result - unfavorable

Negative result - favorable

4: MORE THAN ONE INPUT CLASS

Total Material/ Labor Variance

Total actual cost of material or labor minus the total standard cost of material or labor.

The total variance is broken down into:

1. Material price/labor rate variance

Material Price (Labor Rate) Variance

The total price variance of multiple inputs is the sum of the price variances for each input of the
mix. The variance for each input is calculated individually using the price variance formula:
(Actual Price - Standard Price) x Actual Quantity

Material Quantity (Labor Efficiency) Variance

The total quantity or efficiency variance of multiple inputs is the sum of the quantity variances
for each input of the mix. The variance for each input is calculated individually using the
quantity variance formula.
(Actual Quantity - Standard Quantity) x Standard Price

Shortcoming of Total Variances

The total variance does not tell us why it happened:
 Maybe the wrong amount was used, or
 Maybe the mix was wrong, or
 Combination of these

Subvariances for Quantity Variance

The materials quantity variance and the labor efficiency variance may be broken down into two
sub-variances:
 Mix variance
 Yield variance

Additional Calculations
 Weighted Average Standard Price of the Actual Mix (waspAM) - How much one unit
of the actual mix (AM) used SHOULD have cost using the standard price (sp).
 Weighted Average Standard Price of the Standard Mix (waspSM) - How much one
unit of the standard mix (SM) used SHOULD have cost using the standard price (sp).

Mix Variance (Materials or Labor)

The part of the quantity variance that is caused by the mix of materials (ingredients) actually
used being different from the mix that should have been used.
(waspAM - waspSM) x Actual Quantity

Yield Variance (Materials or Labor)

Results from a difference between the total quantity of the inputs that were actually used to
produce the actual output and the total standard quantity that should have been used to produce
the actual output.
(Actual Quantity - Standard Quantity) x waspSM

Multiple Input Example

5: FACTORY OVERHEAD VARIANCE
Total Overhead Variance
 Actual total variable and fixed overhead incurred (money actually spent on these items)
 Total variable and fixed overhead applied to production using predetermined rates.

Total Variable Overhead Variance

Also called the flexible budget variance.
Equal to the difference between the actual variable overhead incurred and the standard variable
overhead applied, based on the standard usage of the allocation base.
The total variable overhead variance is calculated as:
Actual total variable overhead incurred (AP x AQ)
- Flexible budget amount of variable OH (SP x SQ)
= Total Variable Overhead Variance

Variable Overhead Spending Variance

Determines how much of the total variance was caused by the actual variable overhead rate unit
of the allocation base actually used being different from the standard overhead application rate
per unit of the allocation base actually used.
(AP - SP) x AQ

Variable Overhead Spending Variance

Actual variable overhead incurred (AP x AQ)
- Budgeted variable overhead based on inputs ACTUALLY USED (SP x AQ)
= Variable Overhead Spending Variance

Variable Overhead Efficiency Variance

Determines how much of the total variance was caused by the actual number of the allocation
base (direct labor hours, number of parts…) used being different than the expected number of the
allocation base to be used.
(SQ - AQ) x SP

Variable Overhead Efficiency Variance

Budgeted variable OH based on inputs actually used (SP x AQ)
- Standard variable OH allowed for/applied to production (SP x SQ)
= Variable overhead efficiency variance

Fixed Overhead Variances

Because of the nature of these expenses, much less control can be maintained or effected over
these costs.

Total Fixed Overhead Variance

Difference between the actual fixed overhead incurred and the amount that was applied using
the standard rate and the standard usage for the actual level of output.
Actual Fixed Overhead Incurred
- Standard Fixed Overheads Applied
= Total Fixed Overhead Variance
Fixed Overhead Spending Variance
Difference between the actual fixed overhead costs and the budgeted fixed overhead amount.
Actual Fixed Overhead Incurred
- Budgeted Fixed Overhead
= Fixed Overhead Budget/Spending Variance

Fixed Overhead Production-Volume Variance

Difference between the budgeted amount of fixed over-head and the amount of fixed overhead
applied.

Budgeted Fixed OH (Static Budgeted Amount)

- Standard Fixed Overheads Applied
= Fixed OH production-volume variance

Total OH FLEXIBLE BUDGET Variance

Difference between actual overhead incurred and the flexible budget overhead is made up of
three of the four variances:
1. Variable OH Spending Variance
2. Variable OH Efficiency Variance
3. Fixed OH Spending Variance

Actual OH Incurred
- Flexible Budget Total OH
= Total OH Flexible Budget Variance

2-way, 3-way and 4-way Analysis

 In 4-way variance analysis, each of the four sub-variances are looked at and measured
individually.
 In 3-way variance analysis, the variable and fixed overhead spending variances are
combined into one spending variance.
 In 2-way variance analysis, the spending variance is combined with the variable overhead
efficiency variance in what is called the controllable variance.
6: FACTORY OVERHEAD EXAMPLE
7: SALES VARIANCE

Sales Variance Overview

Sales variance are very similar to the input variances.
1. Determining if it is favorable or unfavorable
2. The ‘price’ that is used in the formulas
3. The quantity used for the “standard quantity” in the quantity variance

1. Determining if Un- or Favorable

Since the Standard is subtracted from actual, a positive result in the formula is a favorable
variance for revenue related items.
2. Use Contribution When Able
When information for contribution is available, use contribution instead of sales price as the
‘price’ in the formulas.

3. Sales Variance “Standard Quantity”

The sales quantity variance needs to be calculated using the master budget level of sales instead
of the flexible budget level of sales.

Two Sales Variance – Single Product

As with inputs, there are two variances for sales when there is only one product
A. Sales price variance, and
B. Sales volume variance

A. Sales Price Variance

Measures the impact of a change in the contribution from each unit (or price of each unit)
(AP - SP) x AQ

B. Sales Volume Variance

Measures the impact of the difference in sales volume between the actual results and the
STATIC budget
(AQ - SQ) x SP

SALES VARIANCE – MULTIPLE PRODUCTS SOLD

More Than One Product Is Sold

 When more than one product is sold, the sales price variance and the sales volume
variance are calculated for each individual product and then added together.
 The sales volume variance is subdivided into the:
1. Sales mix variance, and
2. Sales quantity variance

1. Selling Price Variance

Calculated each product’s individual sales price variance and sum the variances:
∑ (AP - SP) x AQ
2. Sales Volume Variance
Calculate each product’s individual sales volume variance and the sum the variances:
∑ (AQ - SQ) x SP

2A. Sales Mix Variance

(waspAM - waspSM) x AQ

2B. Sales Quantity Variance

(AQ - SQ) x waspSM

Example:
8: VARIANCE OR SERVICE COMPANIES

Variance Analysis – service companies

 A service company’s “product” is the service it provides
 Service companies can have the following variances: price, volume (quantity), mix
(related to the services they provide) and overhead.

Both Services and Products

If the company provides both a service and a product, the company should segregate its service
revenue from its product revenue in its accounting systems.

Overhead Analysis for a Service Company

 Variance analysis can also be done by any company on its selling, and general and
administrative overhead costs
 A service organization may have fixed overhead costs.

Market Variances
 The sales quantity variance can also be analyzed as to the impact of the market on sales.
 The difference between actual and expected sales may be connected to two areas related
to the market.
1. The actual market was bigger or smaller than was expected, and/or
2. The company’s market share was bigger or smaller than expected.

Market Size Variance

Measure how much of the sales quantity variance was caused by the market itself being bigger or
smaller than was expected.

[(Actual Market Size in Units – Expected Market Size in Units) x Expected Market Share %]
x Standard Weighted Average Contribution Margin per Unit.
Market Share Variance
Measure how much of the difference in the budgeted contribution margin was caused by actual
market share being different from the expected market share.

[(Actual Market Share – Expected Market Share) x Actual Market Size in Units]
x Standard Weighted Average Contribution Margin per Unit.