7.4 Product Costing and Variance Analysis for Planners

Cost data reaches you as a constraint, not an accounting exercise. Change a lot size, a supplier, or a schedule, and some costs move while others do not — ECM Section IV.E, Monitor Product Costs, asks whether you know which.

Types of Product Cost

Direct costs trace to a unit: direct material (components on the bill of material) and direct labor (hours a routing consumes). Indirect costs support production but cannot be traced economically to one unit — supervision, maintenance, lubricants, tooling. Overhead is the pooled indirect cost of the operation, applied through an allocation rate.

Cut the same costs a second way, by behavior:

• Variable cost — total rises with volume, per-unit flat: direct material, per-unit freight, piece-rate labor.
• Fixed cost — total flat across the relevant range, per-unit falls as volume rises: depreciation, salaried supervision, leases.
• Semi-variable (mixed) — fixed base plus a usage-driven element: utilities, usage-based maintenance contracts.

That per-unit behavior of fixed cost is where exam items are set: producing more units spreads fixed cost thinner, so the unit looks cheaper with no efficiency gain.

Landed cost = unit price + freight + duty/tariff + insurance + handling and customs clearance — what an item costs delivered to your dock. Total cost of ownership (TCO) adds the downstream cost that decision creates: defect disposition, carrying cost on a longer pipeline, expediting when lead time breaks, and end-of-life obsolescence.

Worked comparison: offshore versus regional

Annual demand 20,000 units. Supplier A is offshore on a 70-day ocean transit; B is regional on 10 days at a higher price.

Those adders are computed. A's 70-day pipeline and minimum order quantity hold ~6,400 units; at 25% carrying on $11.50 landed (= $2.875/year) that is $18,400 / 20,000 = $0.92. B holds 1,150 units: $3,608 / 20,000 = $0.18. A's quality line is 2.5% defects at $14 disposition (= $0.35).

Landed cost says A wins by $1.05 per unit — $21,000 a year. TCO says B wins by $0.42 — $8,400 a year. TCO is the right basis, and the reversal comes from cost that purchase price variance never shows.

Costing Methods

The absorption-costing trap

Fixed overhead rides into inventory with the unit. Build 10,000 units nobody ordered and the overhead they absorbed is deferred on the balance sheet instead of hitting cost of goods sold, so reported profit rises in the period you overbuild. Variable costing expenses it regardless — which is why inventory policy must never be steered by a plant-level absorption metric.

Activity-based costing versus ABC classification

The exam puts both meanings in one answer set. They share three letters and nothing else:

• Activity-based costing (IV.E.2) builds cost pools around activities — setups, material moves, purchase orders, engineering changes, inspections — and assigns them with cost drivers such as number of setups or change orders. A plantwide direct-labor rate smears overhead evenly, so high-volume simple items subsidize low-volume complex ones. ABC strips that subsidy out: the custom spare needing four setups a year absorbs the cost it causes, and often proves unprofitable.
• ABC inventory classification (Domain VI) is the Pareto ranking of items by annual dollar usage into A, B, and C classes to set cycle-count frequency. No pools, no drivers, no overhead.

Costs Related to Quality

Cost per defect climbs sharply down that list. Prevention is the cheapest place to spend and external failure the most expensive, because an escaped defect carries the manufacturing cost plus replacement, freight, and lost goodwill. Cutting appraisal without adding prevention just converts internal failure into external failure.

Variance Analysis

A variance is actual cost minus standard, planned, or budgeted cost. Standards are set per unit as a standard quantity and a standard price, and the gap is split so a cause can be assigned:

• Material price variance = (actual price − standard price) x actual quantity — normally owned by purchasing
• Material usage (quantity) variance = (actual quantity − standard quantity allowed) x standard price — normally owned by operations
• Standard quantity allowed = units produced x standard quantity per unit

A positive result is unfavorable; a negative result is favorable.

Worked example

Standard is 3.0 kg per unit at $8.00/kg. You build 4,000 units and consume 12,600 kg bought at $7.60/kg.

• Standard quantity allowed = 4,000 x 3.0 = 12,000 kg
• Price variance = ($7.60 − $8.00) x 12,600 = −$5,040 = $5,040 favorable
• Usage variance = (12,600 − 12,000) x $8.00 = $4,800 unfavorable
• Net material variance = −$5,040 + $4,800 = $240 favorable

Reconcile: actual 12,600 x $7.60 = $95,760 against standard 12,000 x $8.00 = $96,000 — a $240 favorable gap. The components always sum to the total material variance; use that as your check.

Read the story, not the sign. Purchasing bought material 5% under standard and the shop burned 600 extra kilograms running it. The headline is favorable; the reality is a supplier-quality problem that also consumed capacity.

Where planner variances come from

• Obsolescence — write-off or revaluation, plus a scrap variance when dead stock is dispositioned.
• Scrap and yield loss — unfavorable usage variance; fix the scrap factor in the item master or BOM.
• Rework — unfavorable labor efficiency and overhead variance: hours consumed, no added output.
• Repairs — unfavorable maintenance spending; downtime also drives an efficiency variance.
• Returns — external failure cost plus a reversal distorting period usage and COGS.
• Defective output — unfavorable usage variance now, plus a schedule shortfall driving expediting.

If the standard itself is wrong — a stale scrap factor, an out-of-date routing, a price nobody has paid in two years — every period generates a variance no shop-floor action can close. Correcting the standard is a legitimate answer.

What the Exam Tests

CPIM tests cost literacy for planning decisions, not accountancy. You will be asked which cost moves when a lot size, a source, or a schedule changes: doubling the lot halves setup cost per unit but doubles cycle-stock carrying cost; offshoring cuts unit price but adds pipeline, quality, and obsolescence cost; pulling a schedule in adds carrying cost while pushing it out adds expediting risk.