24-1. chapter 24 c ontrol through s tandard c osts

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CHAPTER 24CHAPTER 24

CONTROL THROUGHSTANDARD COSTS

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CHAPTER 24CHAPTER 24

CONTROL THROUGHSTANDARD COSTS

Caution! This chapter is second only to Caution! This chapter is second only to Chapter 15 (bonds) for the amount of grief Chapter 15 (bonds) for the amount of grief

it causes most students in this course.it causes most students in this course.

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Up to this point in the course, we have been using actual costs.

This chapter considers standard costs (i.e., what costs should be under stated conditions). The achievement of standard represents

a reasonable and acceptable level of performance.

Standards for materials, labor, and overhead are determined through engineering studies and time and motion studies.

Nature of Standard CostsNature of Standard Costs

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Standard Costs are

Based on carefullypredetermined amounts.

Used for budgeting labor, materialand overhead requirements.

Used for variance analysis.

Benchmarks formeasuring performance.

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Type of Product Cost

Am

ou

nt

DirectMaterial Direct

Labor ManufacturingOverhead

Actual costsStandard costs - what costs should be under

stated conditions.


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Am

ou

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Standard cost variances -amounts by which

actual costs differs fromstandard costs.

Standard Cost VariancesStandard Cost Variances

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Am

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The materials variance is unfavorable because the actual

cost exceeds the standard cost.

The overhead variance is favorable becausethe actual cost is less

than the standard cost.


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Am

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Managers focus on standard cost variances, a practice known as

management by exception.


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Why are variancesimportant to me?

They point to causes ofproblems and directions

for improvement.

They trigger investigations in departments having

responsibility for incurringthe costs.

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Setting Standard CostsSetting Standard Costs

Should we usepractical standardsor ideal standards?

Engineer

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Practical standards should beset at levels that are currentlyattainable with reasonable and

efficient effort.

Productionmanager

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I agree. Ideal standards, that are based on perfection, are

unattainable and therefore discouraging to most employees.

HumanResourcesManager

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This is your decision. I’m here to advise you and account for the

resulting transactions.

ManagerialAccountant

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Advantages of Standard CostsAdvantages of Standard Costs

Advantages Cost savings inrecord-keeping

Improved cost control and performance

evaluation

Better Informationfor planning anddecision making

Possible reductionsin production costs

More reasonableand easier inventory

measurements

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Disadvantages of Standard CostsDisadvantages of Standard Costs

DisadvantagesEmphasis onnegative

exceptions maylower morale.

Emphasis on negativeexceptions may

lead to under-reporting.

It may be difficultto determine

which variancesare significant.

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Are standards the same as budgets?

A standard is the expected cost for one

unit.

A budget is the expected cost for all

units.

Use of Standard Costs in Use of Standard Costs in Developing BudgetsDeveloping Budgets

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SpecificsSpecifics

O.K., let’s get down and dirty with some

specifics!

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The total standard cost for one unit of finished product is the sum of: Standard cost for direct materials

Standard cost for direct labor

Standard cost for manufacturing overhead

necessary to produce one unit of the product.

Types of Standard CostsTypes of Standard Costs

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Setting StandardsSetting StandardsDirect MaterialsDirect Materials

UsageStandards

PriceStandards

Use product design specifications

Use competitivebids for the quality

and quantity desired

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Standard CostsStandard CostsDirect MaterialsDirect Materials

Standard costcost for direct materials is standard priceprice for one unit of raw

material (pound, yard, etc.) multiplied by the standard quantityquantity of raw material

to produce one unit of product

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Standard priceprice is the amount that should be paid for each unit of raw material.

Standard quantityquantity is the amount of raw material that should be used to produce one unit offinished product.

The standard material costcost for one unit of product is:

standard quantityquantity standard priceprice for of material one unit of material required for one

unit of product

×

Standard CostsStandard CostsDirect MaterialsDirect Materials

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Standard CostsStandard CostsDirect Materials ExampleDirect Materials Example

Standard priceprice is the amount that should be paid for each unit of raw material.e.g.., each sheet of plywood should cost $6

Standard quantityquantity is the amount of material that should be used to produce one unit of finished product.e.g., each table should take 5 sheets

The High Point Furniture Company makes top quality tables from sheets of plywood.

863

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Standard priceprice is the amount that should be paid for each unit of raw material.e.g.., each sheet of plywood should cost $6

Standard quantityquantity is the amount of material that should be used to produce one unit of finished product.e.g., each table should take 5 sheets

Standard costcost is standard priceprice times standard quantityquantity for one unit of producte.g., $6 X 5 sheets = $30

Standard CostsStandard CostsDirect Materials ExampleDirect Materials Example

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EfficiencyStandards

RateStandards

Use time and motion studies for

each labor operation

Use wage surveys and

labor contracts

Setting StandardsSetting StandardsDirect LaborDirect Labor

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Standard costcost for direct labor is standard wagewage raterate for one hour of

labor multiplied by the standard number of labornumber of labor hours needed to

produce one unit of product.

Standard CostsStandard CostsDirect LaborDirect Labor

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Standard wage ratewage rate is theamount that should be paidfor each hour of labor.

Standard number of hoursnumber of hoursis the number of hours thatshould be worked to produceone unit of finished product.

The standard labor costcost for one unit of product is:

standard numbernumber standard wage ratewage rate of labor hoursof labor hours for one hour for one unit of product

×

Standard CostsStandard CostsDirect LaborDirect Labor

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The High Point Furniture Company’s dining room tables are made by highly

skilled, hourly paid carpenters. Standard wage ratewage rate is the amount that

should be paid for each hour of labor.e.g.., each hour should cost $10

Standard number of hoursnumber of hours is the number of hours that should be worked to produce one unit of finished product.e.g., each table should take 2 hours

Standard CostsStandard CostsDirect Labor ExampleDirect Labor Example

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Standard wage ratewage rate is the amount that should be paid for each hour of labor.e.g.., each hour should cost $10

Standard number of hoursnumber of hours is the number of hours that should be worked to produce one unit of finished product.e.g., each table should take 2 hours

Standard labor costcost is standard wage wage raterate times standard number of hoursnumber of hours for one unit of finished producte.g., $10 X 2 hours = $20

Standard CostsStandard CostsDirect Labor ExampleDirect Labor Example

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Standard Rate

Select a standard level of output and define

a basis for activity

Setting StandardsSetting StandardsManufacturing OverheadManufacturing Overhead

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Standard CostsStandard CostsManufacturing OverheadManufacturing Overhead

If, however, the overhead rate is based on units of inputinput such as direct labor hours, the denominator is

based on the inputinput labor hours.

The above calculation is really what?

Total budgeted overhead costat the standard level of output

Standard level of output

Standard overhead raterate per unit =

A standard manufacturing overhead raterate is applied for each unit of activity.

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Budgeted overhead costBudgeted overhead cost is thetotal amount of overhead cost that should be incurred for the year to produce at the standard level of output.

StandardStandard level of output level of output is what the activity level for the cost driver should be for the year.

Total budgeted overhead costbudgeted overhead costat the standard level of output

StandardStandard level of outputlevel of output


Standard CostsStandard CostsManufacturing OverheadManufacturing Overhead

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Budgeted overhead costBudgeted overhead cost is the amount of overhead cost that should be incurred to produce at the standard level of output.e.g., total overhead cost = $100,000

StandardStandard level of outputlevel of output is what the activity level for the cost driver should be.e.g., total labor hours should be 20,000

Standard CostsStandard CostsManufacturing Overhead ExampleManufacturing Overhead Example

The High Point Furniture Company applies overhead to tables based on machine hours.

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Total budgeted overhead costbudgeted overhead costat the standard level of output

StandardStandard level of outputlevel of output



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Standard overheadraterate per unit (i.e, hour) =

$100,000

20,000= $5


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Standard overhead costcost is standard overhead raterate times number of activity units for each unit of finished producte.g., $5 X 2 labor hours = $10


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Standard Costs For One Table

Direct materials - $6 X 5 sheets $30

Direct labor - $10 X 2 hours 20

Manufacturing overhead - $5 X 2 labor hours 10

Total standard cost $60

Standard CostsStandard CostsSummary of ExamplesSummary of Examples

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Computing VariancesComputing Variances

Standard cost variance

Amount by which actual cost differs from standard cost for the for the actualactual volume level volume level attainedattained

Favorable variance

Actual cost is less than standard cost

Unfavorable variance

Actual cost is greater than standard cost

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Know how to calculate all six cost variances and what causes each.

* For the actual volume level attained

*

*

***

Computing VariancesComputing Variances872

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Let’s use what we have learned to calculate the six

standard cost variances for a

different company, starting with

direct materials.


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Hanson Inc. has the following material standard to manufacture one Zippy:

1.5 pounds per Zippy at $4.00 per pound

Records last week show 1,700 pounds of material were purchased in May at a

total cost of $6,630. The material was used to make 1,000 Zippies in May.

Computing VariancesComputing VariancesMaterials Price VarianceMaterials Price Variance

AP = $6,630 ÷ 1,700 lbs AP = $3.90 per lb MPV = (AP - SP) x AQ MPV = ($3.90 - 4.00) x 1,700 lbs. MPV = -$170 Favorable

Materials Price

Variance

Zippy

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AP = $6,630 ÷ 1,700 lbs AP = $3.90 per lb MPV = (AP - SP) x AQ MPV = ($3.90 - 4.00) x 1,700 lbs. MPV = -$170 Favorable

Note that the authors’ use of +/- is counter-

intuitive

Computing VariancesComputing VariancesMaterials Price VarianceMaterials Price Variance

Zippy

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GENERAL JOURNAL

Page: 1

Date Description PR Debit Credit

5/10 Materials Inventory 6,800 Materials Price Variance 170 Accounts Payable 6,630

To record purchase of materials

at less than standard cost

*

Materials inventory must always be debited for the actual actual quantity X standard standard price

1,700 lbs. X $4.00 = $6,800

*

Price variance is recorded at time of purchase.

Recording VariancesRecording VariancesMaterials Price VarianceMaterials Price Variance

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Materials Usage

Variance

SQ = 1,000 units × 1.5 lbs per unit SQ = 1,500 lbs MUV = (AQ - SQ) x SP MUV = (1,700lbs - 1,500lbs) x $4.00

MUV = +$800 unfavorable

Computing VariancesComputing VariancesMaterials Usage VarianceMaterials Usage Variance

Zippy

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GENERAL JOURNAL

Page: 1


5/10 Work in Process Inventory 6,000Materials Usage Variance 800 Materials Inventory 6,800

To record use of materials and

establish materials usage variance

Materials inventory must always be relieved for the actual actual quantity X standard standard price

1,700 lbs. X $4.00 = $6,800

*

*

Recording VariancesRecording VariancesMaterials Usage VarianceMaterials Usage Variance

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GENERAL JOURNAL

Page: 1


5/10 Work in Process Inventory 6,000Materials Usage Variance 800 Materials Inventory 6,800

To record use of materials and

establish materials usage variance

Work in Process Inventory must always be debited for the standard standard quantity X standard standard price

(1,000 units X 1.5 lbs.) X $4.00 = $6,000

*

*

Usage variance is recorded at time of use.

Can materials price and usage variances be added to get a total materials variance?

Recording VariancesRecording VariancesMaterials Usage VarianceMaterials Usage Variance

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Now let’s calculate standard cost variances for direct labor.


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Hanson Inc. has the following labor standard to manufacture one Zippy:

1.5 standard hours per Zippy at $6.00 per hour

Payroll records show 1,450 hours were worked at a total labor cost of $8,990 to

make 1,000 Zippies.

Computing VariancesComputing VariancesLabor Rate VarianceLabor Rate Variance

Labor Rate

Variance

AR = $8,990 ÷ 1450 hours AR = $6.20 per hour

LRV = (AR - SR) X AH LRV = ($6.20 - $6.00) X 1,450 hrs

LRV = +$290 unfavorable

Zippy

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Hanson Inc. has the following labor standard to manufacture one Zippy:

1.5 standard hours per Zippy at $6.00 per hour

Payroll records show 1,450 hours were worked at a total labor cost of $8,990 to

make 1,000 Zippies.

Labor Efficiency Variance

SH = 1,000 units × 1.5 hours per unit SH = 1,500 hours LEV = (AH - SH) X SR LEV = (1,450 hrs - 1,500 hrs) X $6.00 LEV = -$300 favorable

Computing VariancesComputing VariancesLabor Efficiency VarianceLabor Efficiency Variance

Zippy

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Recording VariancesRecording VariancesLabor Rate & Efficiency VariancesLabor Rate & Efficiency Variances

GENERAL JOURNAL

Page: 1


5/15 Work in Process Inventory 9,000Labor Rate Variance 290 Labor Efficiency Variance 300 Payroll Summary 8,990

To charge work in process for direct

labor and to establish variances

Note that unlike materials variances, both labor variances are recorded at the same time. (i.e., when

the payroll summary account is cleared out.)

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GENERAL JOURNAL

Page: 1


5/15 Work in Process Inventory 9,000Labor Rate Variance 290 Labor Efficiency Variance 300 Payroll Summary 8,990

To charge work in process for direct

labor and to establish variances

* Work in Process Inventory must always be debited for the standard standard quantity X standard standard price

(1,000 units X 1.5 lbs.) X $6.00 = $9,000

*

*

Source?

Recording VariancesRecording VariancesLabor Rate & Efficiency VariancesLabor Rate & Efficiency Variances

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Now let’s calculate standard cost variances for

manufacturing overhead.


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Overhead is applied to goods produced using a standard overhead raterate.

Overhead rate is set prior to the start of the period.

Total budgeted overhead costat the standard level of outputstandard level of output

Standard level of outputStandard level of output


Standard Overhead RateStandard Overhead Rate

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Standard Overhead Rate

per unit

Contains a variable variable per unit component which stays constant at all

levels of activity.

Contains a fixed fixed per unit component which

declines as activitylevel increases.

Is a function of the projected volumelevel chosen to determine the rate.

(i.e., standard level of outputstandard level of output)

Standard Overhead RateStandard Overhead Rate

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Budget Variance

Is calculated as the difference between total actualactual overhead cost and budgetedbudgeted amount of overhead for the actual volume attainedfor the actual volume attained

Volume VarianceIs calculated as the difference between the

budgetedbudgeted amount of overhead for the actual volume level attainedfor the actual volume level attained

and the appliedapplied overhead at the standard level of outputstandard level of output

Overhead VariancesOverhead Variances

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Overhead VariancesOverhead Variances Budgeted Applied Overhead at Overhead at Actual Actual VolumeActual Volume Standard LevelStandard Level Overhead Level AttainedLevel Attained of Outputof Output

Budget Variance

VolumeVariance

AOH - BOH BOH - Applied OH

AOH = Actual Overhead BOH = Budgeted Overhead

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Budget Variance

VolumeVariance

Budgeted Applied Overhead at Overhead at Actual Actual VolumeActual Volume Standard LevelStandard Level Overhead Level AttainedLevel Attained of Outputof Output

Total Overhead Variance

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Budget Variance

VolumeVariance

Shows how economicallyoverhead services were

purchased and howefficiently overheadservices were used.

Contains both fixedand variable costs.


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Budget Variance

VolumeVariance

Caused by producing ata level other than that

used for computing thestandard overhead rate.

Contains only fixed costs.


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Flexible budgets, showing budgeted amount of overhead for various

levels of activity, are used to analyze overhead costs.


Hanson’s flexiblebudget for overhead

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Overhead VariancesOverhead VariancesExampleExample

Hanson, Inc. has the following flexible budget for overhead:

Hanson applies overhead based on machine hour activityand expects to produce 1,500 Zippies.

(i.e., a standard activity level standard activity level of 3,000 machine hours)

Machine Hours 2,000 3,000 4,000 Zippies 1,000 1,500 2,000

Variable Overhead 4,000$ 6,000$ 8,000$ Fixed Overhead 9,000 9,000 9,000 Total Overhead 13,000$ 15,000$ 17,000$

Zippy

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Variable Overhead 4,000$ 6,000$ 8,000$ Fixed Overhead 9,000 9,000 9,000 Total Overhead 13,000$ 15,000$ 17,000$ Variable Overhead Rate $6,000 ÷ 3,000 machine hours = $2.00 per machine hour (constant at all activity levels)

Fixed Overhead Rate $9,000 ÷ 3,000 machine hours = $3.00 per machine hour (different at each activity level)


Zippy

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Hanson’s actual production for the period was 1,600 Zippies resulting in

3,200 standard machine hours. Actual total overhead cost for the period was

$15,450.


Zippy

Compute the overhead budget and volume variances.

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$15,450 $9,000 fixed + $6,400 variable

$2.00 per hr. × 3,200 hrs.

$15,450 $9,000 fixed 3,200 hrs. + × $6,400 variable $5.00 per hr.

$2.00 per hr. variableplus

$3.00 per hr. fixed


Zippy

Budgeted Applied Overhead at Overhead at Actual Actual VolumeActual Volume Standard LevelStandard Level Overhead Level AttainedLevel Attained of Outputof Output $15,450

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Budget variance$50 unfavorable

Volume variance$600 favorable

$15,450 $9,000 fixed 3,200 hrs. + × $6,400 variable $5.00 per hr.

$15,450 $15,400 $16,000


Zippy

Budgeted Applied Overhead at Overhead at Actual Actual VolumeActual Volume Standard LevelStandard Level Overhead Level AttainedLevel Attained of Outputof OutputLet’s try a slightly

different approach for getting the $15,400 of Budgeted Overhead.

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Hanson’s flexible budget for overhead

Standard Standard activity activity

levellevel

100% 133% 67%

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Hanson’s flexible budget for overhead

Standard Standard activity activity

levellevel

100% 107% 67%

Actual Actual volume volume

level level attainedattainedBOH

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GENERAL JOURNAL

Page: 1


5/31 Manufacturing Overhead 550Overhead Budget Variance 50 Overhead Volume Variance 600

To record overhead variances and

close manufacturing overhead

Overhead account is closed and both variances are recorded at end of period in the same entry.

Recording Overhead VariancesRecording Overhead Variances

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Investigating VariancesInvestigating Variances The decision to investigate a variance is

based on: Dollar amount of variance. Size of variance relative to cost incurred. Controllability of cost associated with

variance.All of these relate to the “Management by Exception” concept

Variances may be interdependent. Performance reports contain variances

along with budgeted and actual cost data.

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Variance Analysis andVariance Analysis andManagement by ExceptionManagement by ExceptionNow that I know all about

standard cost variances, howdo I apply that management

by exception concept?

Well, sir, you should keep in mind what my daddy taught me: "If it ain't broke, don't fix it” and

"Don't sweat the small stuff."

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Can you tell mewhich variances to

investigate?

Variance Analysis andVariance Analysis andManagement by ExceptionManagement by Exception


Am

ou

nt

DirectMaterialDirect


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Possible guidelines are:Dollar amount or percentage of the standard Controllability of the cost variance

Variance Analysis andVariance Analysis andManagement by ExceptionManagement by Exception

Can you tell mewhich variances to

investigate?

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Reporting VariancesReporting Variances

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Variance may be closed entirely to Cost of Goods Sold (normal case for small variances) or

Variance may be closed by prorating to Work in Process, Finished Goods, and Cost of Goods Sold based on relative size of these accounts.

Disposing of VariancesDisposing of Variances

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THE ENDTHE END

24-1. chapter 24 c ontrol through s tandard c osts

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