218 Understanding the Numbers
enter a budgeted number in the ledgers in anticipation of an actual number. For
instance, city governments will enter budgeted revenues as a debit on the left
side of the ledger account. Then when the sales are actually made, they will
enter the actual revenues as a credit on the right column of the ledger account.
The effect is that at the end of the year, only variances are left in accounts. For
instance, sales greater than expected would leave a credit variance.”
Standard Variable Costs
“The second exception involves so-called standard cost systems. In a typical
implementation, the standard cost of a product, not the actual cost incurred, is
entered into the work-in-process account. The difference between the stan-
dard cost and the actual cost creates a variance—in the actual accounts. For
example, in the case of paper used, the inventory account would be charged
with the standard $4.00 for every ream used but only $3.50 would be paid to
the supplier. The difference of $0.50 would be shown in a separate variance
account in the books of the company.
“The existence of a credit variance in the accounts indicates that the bud-
geted unit cost exceeds the actual unit cost, that is, there is a favorable vari-
ance. Were the variance a debit, it would be unfavorable.
“By the end of the job, after they have produced 1,200 reams, they will
show in their accounts a variance of $0.50 per ream on all their variable costs
times 1,200 reams, or a credit of $600. This is the same favorable $600 variance
that we saw in Exhibit 7.4 when we subtracted the actual cost from the f lexible
budget. Standard cost systems, in other words, track the f lexible budget.
“Each of these variances is identical to the variances computed above;
each can be stated in percentage terms to indicate their relative size, that is,
material costs are down 12.5%, labor costs are even, and variable overhead
costs are down 16.67%. The key point to realize is that variances generated by
a standard cost system are identical to those generated by a budgetary control
system—once one removes the volume effect.”
Standard Fixed Costs
“The parallels between standard cost systems and budgetary control systems
do not extend to fixed costs, unfortunately. The reason lies in the way fixed
costs are applied to products. In a standard cost system, a fixed overhead rate
is established at the start of a period by dividing the budgeted fixed overhead
by the budgeted volume. In our case, the predetermined fixed overhead rate
was $4,000 divided by 1,000 reams, which equals $4.00 per ream. The pre-
determined fixed overhead rate is therefore based on the static budget.
“Fixed overhead is then applied to goods as they are produced by multi-
plying the number of reams produced by this overhead rate. In this case, one
charges $4.00 of fixed overhead to each of the 1,200 reams produced. The re-
sult is $4,800, which is known as the appliedoverhead. The problem is that this